Buying CMBS Becomes Trickier for CMBS 2.0 and 1.0

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WE’RE HEARING… investors still want to buy in the commercial mortgage-backed securities sector while performance is relatively good and they have more options, but they are increasingly mindful that recent origination standards are slipping and there are risks to be aware of in CMBS 1.0, too.

DBRS managing directors Mary Jane Potthoff and Erin Stafford and senior vice presidents David Nabwangu and Adrienne Young tell us the portion of recent CMBS collateral that is either interest-only or partially IO, for example, has increased to 40% of all transactions by loan balance from below 15%.

“While these levels are well below legacy CMBS averages, they have nonetheless moved substantially since 2010,” they noted in a recent report.

Because issuance so far has boomed, the DBRS researchers tell us some investors “have avoided the recent new issuance altogether and prefer the yield that is offered or legacy products.”

Investors may do this in some cases due to the belief that the legacy products have more of a track record and their performance may thus be easier to size up.

As Deutsche Bank research analysts Harris Trifon and Dave Zhou tell us in a June 18 report, unprecedented developments can still occur in the legacy CMBS world, but in some respects their causes may be clearer.

For example: A CMBS deal originally issued in May 2005, which was one of the first with a super-senior AM and AJ structure, “has become the first-ever conduit deal to take a loss on its junior AAA tranche,” according to DB. The amount of the loss, $133 million, “is the largest to date in a CMBS transaction.”

Behind the loss, the analysts find “a familiar issue, a previously modified loan.”

“Large modified loans are increasingly becoming problems again and will continue to put special servicers, and by extension CMBS investors in uncomfortable positions in the months ahead,” the Deutsche Bank researchers tell us.

As Barclays securitized product researchers Keerthi Raghavan and Aaron Hann tell us, another example of a notable legacy sector concern recently was a reduced appraisal on a retail loan in another 2005 deal “that implies a near total loss.”

This also is an example of a broader issue to watch for in the legacy CMBS market, the Barclays researchers tell us, noting that, “The loan is another example of a distressed retail property that is likely to be liquidated with extremely high losses.”

Bonnie Sinnock is managing editor of National Mortgage News and editor of Origination News. She has been covering the mortgage industry since 1995.