Private label CMBS issuance, specifically, is on track to reach as high as $95B in 2014, which would be a 15% increase over the year prior and marks the fourth consecutive year of growth since the market reopened in 2010. CMBS market share as a percentage of total origination volumes has correspondingly risen to 25% as of 1H14 compared to 18% in 2010, but it is well below the 50% market share that drove issuance to nearly $250B prior to the financial crisis. We expect that CMBS market share will increase to greater than 30% in the coming years as issuance increases to above $100B. Underwriting Standards Have Loosened… Credit quality has declined as CMBS originators have loosened underwriting standards to win market share. Consider that weighted average loan-to-values have increased to 65% in 2014 from 58% in 2010 while weighted average debt yields declined to 10.7% from 13.7% in 2010. …But Still More Conservative Than Pre-Crisis That being said, our analysis shows that current underwriting standards remain more conservative than those of legacy CMBS loans. We do note an increase in the percentage of loans secured by properties located in secondary and tertiary markets, which is a fundamental difference compared to legacy CMBS deals and a potential reason for concern. Loan-to-Values Higher But Below Pre-Crisis Peak Weighted average LTVs have trended higher over the past several years, from 53% as of 3Q10 to 66% as of 3Q14. However, they remain well below the levels observed prior to the financial crisis when they peaked at 71% as of 2Q07. Debt Yields Decline to Below 10%, but Spread to 10-Year Treasury Rate Remains Stable Weighted average debt yields, on the other hand, are at the lowest levels since the beginning of 2005, after declining to 9.6% as of 3Q14 — the first time debt yields have trended below 10%. That being said, the debt yield spread to the 10-year Treasury rate remains above 7%, which is 200 bps higher than the pre-crisis tight of 5.12% in 2Q06. CRE Finance World Winter 2015 8 Exhibit 3 LTVs Rising and Debt Yields Declining Since 2010 Source: Offering Documents, Morgan Stanley Research Pro Forma Underwriting on the Rise But Below Pre-Crisis Pro forma underwriting is on the rise in recent CMBS 2.0 deals, but it remains well below where it was pre-crisis. For instance, as of 3Q14, the most recent NOI was a weighted average of 6% below the underwritten NOI compared to a pre-crisis peak of -13.5% in 4Q07. The prevalence of pro forma underwriting in legacy CMBS deals may also indicate that legacy CMBS LTVs and debt yields were artificially low since, in many cases, the underwritten NOIs never materialized. This suggests that the difference in underwriting standards between CMBS 2.0 deals and legacy CMBS deals may be even more pronounced. We measure pro forma underwriting by comparing the delta between the most recent report NOI at the time of securitization and the underwritten NOI (MR NOI / UW NOI – 100%). A negative percentage reflects that the U/W NOI was higher than the most recent NOI. A Growing Percentage of Loans Are Secured by Properties in Secondary and Tertiary Markets The percentage of loans secured by properties located outside the top 25 MSAs has increased towards 40% as of 3Q14 compared to a pre-crisis low of less than 30% as of 3Q07. This is one of the biggest fundamental differences compared to legacy CMBS and an increasing source of debate among investors: would one prefer Class A properties in primary markets with too much debt or Class B properties located in secondary/tertiary markets with more conservative leverage? The State of the Credit Cycle
CREFW-Winter Edition
To see the actual publication please follow the link above