Race to clinch CMBS loans before rule change

IFR 2144 30 July to 5 August 2016
3 min read
Joy Wiltermuth

Lenders in the CMBS market are making a mad dash to write loans before new risk retention rules take effect later this year that could slam the brakes on deal flow.

Commercial mortgage bonds were walloped by volatility in the first half of the year, as spreads marched wider and new originations sputtered.

But a few smooth weeks of deal flow have put the bounce back in lenders’ steps – just in time for loans to close before the new risk retention rules take hold.

A typical CMBS loan takes a month to sell and another 45–60 days to close, said David Pascale Jr, at Los Angeles real estate brokerage George Smith Partners.

In theory, that gives banks just enough time to package their property loans for sale in CMBS deals before the “skin-in-the-game” rules kick in on December 24.

The US$566bn CMBS industry is still searching for answers to how best to comply with the tighter rules, which will require banks to keep 5% of each trade they create or find investors to hold it instead.

“[CMBS lenders] are busy but certainly getting more conservative and worried about regulations,” said Dan Lisser at real estate broker Marcus & Millichap Capital Corp.

“No matter how good things are now, it is impossible to tell what happens to spreads 40 days from now.”

Sector rallies

The hunt for yield in US assets has in recent weeks dramatically compressed the amount of spread offered to investors in new benchmark 10-year CMBS with Triple A ratings.

The sector’s most recent deal, a US$893.9m trade of loans originated by JP Morgan and Deutsche Bank, priced its benchmark class of bonds last week at swaps plus 108bp – the tightest print so far this year.

“No matter how good things are now, it is impossible to tell what happens to spreads 40 days from now”

For investors looking to buy properties with CMBS financing at going rates of roughly 4.25% on 10-year mortgages, borrowers would be hard-pressed to find cheaper debt.

“When you are in the low 4s, that’s the best pricing I’ve seen in CMBS in 20 years,” Pascale at GSP said.

Trouble spots

But those who remember how the abundance of cheap debt helped propel the last wave of commercial property defaults – once credit dried up – would be forgiven some reservations.

Moody’s reported earlier in July that CMBS leverage has held at an all-time high of 118.6% over the past two quarters versus the prior peak in 2007 of 117.5%.

Investors have taken losses of some US$33.2bn on the US$955.7bn of CMBS debt sold since 2005, according to data provider Trepp, and that figure is expected to rise in the coming months.

Some US$125bn of 10-year CMBS loans will mature in the next 16 months under tighter credit conditions, according to Bank of America Merrill Lynch analysts.

“When bank lending standards begin to tighten, and when conduit lending standards become more restrictive as risk retention goes into effect, some borrowers that could have refinanced successfully last year may find themselves unable to do so,” the analysts wrote recently.

Ultimately, losses for bondholders will hinge on the ability – and willingness – of borrowers to stand by properties financed largely with other people’s money.

“The cost and availability of debt is crucial,” said one CMBS analyst.

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