The Quality of CMBS Issuance Today

CRE Finance World, Winter 2014

The Quality of CMBS Issuance Today n the resurgence of any asset class in the capital markets after a significant or prolonged downturn, there always emerges a heated debate among the cognoscenti about whether it is a true recovery, an unsustainable run up, an isolated blip, already overheating or at risk of a bubble. Dynamic markets must always be going up or down, never stabilized. Each financial publication or internet blog offers the diametrically conflicting opinions of their various commentators and “experts” and the differing perspectives on the data often on the same page of the publication. What does not generally occur in this cacophony is a genuine debate vetting these different opinions and perspectives as to the meaning of the accumulating data. “What does the data mean?” is the question. Henry Adams, the historian, said in his autobiography “The Education of Henry Adams” that “Nothing in education is so astonishing as the amount of ignorance it accumulates in the form of inert facts.” In an effort to inform this debate in a public forum of market players, CREFC, as part of its educational mission, recently held an After- Work Seminar panel discussion entitled “Outlook on CMBS Credit Quality” in New York City. The panel was comprised of: a major loan originator and CMBS issuer; three active B-piece buyers; and a major credit rating agency moderated by a loan originator. Except for the absence of a senior investor of rated bonds, it was a seemingly diverse representation of the various constituencies involved in the current CMBS market assembled by CREFC to inform the ongoing debate about whether origination/issuance is at CMBS 2.0 moving forward to 3.0 or reverting to 1.5 or worse. As if to set the stage for the Elephant in the Room of CMBS, there was a pre-panel presentation by CREFC Government Affairs about the current status of the current federal agencies’ Risk Retention Rules for CMBS and CREFC’s current efforts in attempting to mitigate some the problematic provisions of the reproposed rule. The panel’s discussion focused on the credit quality of the loans being originated to be securitized but also on the impact of the current deal sizes and competition on that qualitative factor. There was general agreement that the originations and the resulting CMBS issuance would grow in 2014 albeit with a tacit recognition of the possible consequences of the final regulatory risk retention CRE Finance World Winter 2014 32 requirements as well as Basel III. There was some acknowledgement of franchise finance loans and parking lots sneaking into pools. But the group was encouraged by the entry of more B-piece buyers and new originators into the market, which should help in the refinance of the looming maturities of the next several years. While most conduit deals now average 60–65 loans, the number of loans being pooled in some cases is as many as 80–90 but still not quite pre-crisis levels. Yet the overall pool size seems to be hovering at $1–1.2 billion although there is no constraint on capital or due diligence resources limiting deal size. The senior investors may have an issue with deal size notwithstanding the benefits of scale and liquidity of larger deals and the credit rating agencies still placing a value on greater diversification of pool assets. Some panelists thought that deal sizes would begin to increase in 2014. The rating agency panelist indicated that in his view, the top ten loans in pools were clearly getting “chunky” and that it was beginning to feel like 2005-2006 today — not just because of higher LTV ratios but because of balloon date LTVs. As interest rates rise, debt coverage will fall and will be back to 2007. The increase in full and partial term interest only loans are the culprit and the credit question will be: can you refinance the entire resulting balloon? However, IOs cannot be assessed in isolation because at a lower LTV e.g., 55% an IO might be acceptable. The B-piece buyers concern with the IOs is the reduction in the amount or lack of deleveraging during the term — the longer the IO term, the greater the impact on the ability to refinance. There is a fear of “yield to death” if you cannot obtain a par payoff for refinancing the loan at maturity. As to market discipline exercised by the B-piece buyers in their “gatekeeper” role, the B-piece buyers indicated that while there were still requests for “kick-outs” of questionable loans in their due diligence process, there is a great deal more pushback from the issuers than pre-crisis. Prior to 2007, it was simply a cost of doing business as the issuers pools were substantially bigger (150-200 loans) and their PNLs were larger. But today’s B-piece buyer due diligence is more intense. Loans originally slated for a pool fail to close, which is not a kick out. But B-piece buyers expect originators and issuers to have answers and/or mitigate for their issues in particular loans. There is more data today and the disclosure is better with detail of non-top ten loans. I Joseph Philip Forte Partner DLA Piper LLP


CRE Finance World, Winter 2014
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