A publication of Winter issue 2015 sponsored by CRE Finance World Winter 2015 9 Exhibit 4 Historical Percentage of Loans Secured by Properties Located Outside the Top 25 MSAs Source: Trepp, Morgan Stanley Research This isn’t surprising as our analysis finds that CMBS owned a 22% market share in major markets in 1H14, compared to a 23% market share in secondary markets and a 45% market share in tertiary markets. CMBS originators will need to increase market share towards 30% for issuance to exceed $100B in the coming years, which may be driven by continued growth of secondary and tertiary market share. Underwriting Standards Likely to Continue to Loosen; It’s Just a Matter of How Far and Fast We believe underwriting standards will need to continue to loosen given the forthcoming wall of maturities. An average of $350B of loans is scheduled to mature across all lender types over each of the next 3 years. Many of these loans will be difficult to refinance upon their maturity date without recapitalization by the borrower and/or looser underwriting standards. For instance, our analysis of the universe of CMBS loans finds that only 37% of the loans scheduled to mature in 2017 have debt yields greater than 10%, and 65% have debt yields greater than 8%. By comparison, our analysis of 2014-vintage loans shows that 64% had greater than a 10% debt yield and nearly 85% had a debt yield greater than 8%. The historical refinancing rate across vintages of around 80% may therefore be higher than what can be expected for the loans maturing over the next 3 years without looser underwriting standards. Risk Retention and Credit Quality Regulators adopted the long-awaited final rules regarding credit risk retention mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) on October 22, 2014. In the CMBS sector, the final rules include limited changes over the previous re-proposal, with the notable exception of eliminating the cash flow trigger test. The rules will go into effect in late 2016, just prior to the wave of 2007 vintage loans starting to mature. In our view, CMBS may become more expensive to issue, resulting in the cost of financing widening, which would in turn make CMBS originations less competitive to alternative lenders such as REITs, life insurance companies and banks. This may incentivize CMBS lenders to originate lower-quality loans at wider spreads in order to maintain market share, but they could face pushback from a smaller group of b-piece buyers who have the capability and the desire to hold bonds for a minimum of five years. New structural alternatives may emerge to satisfy risk retention. We think the winner may be CREL CDOs since the issuers typically retain greater than 5% of the market value of the deal given that they serve as financing vehicles (see The Evolution of CREL CDOs, April 7, 2014, for further detail). not all article readers will have access to MS Research Over the near term, we expect b-piece buying to accelerate as deals issued between now and when the rules are adopted in two years will be grandfathered. Therefore, b-piece buyers will retain the right to opportunistically sell their bonds in the secondary market to enhance their ‘base case’ yield and shorten the investment payback through interest proceeds alone (assuming no bond interest shortfalls). Please see our May 7, 2014, report Analyzing B-Piece BWIC Volumes for further detail. The State of the Credit Cycle
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