Even as the ugly specter of the 2007 vintage of commercial mortgage-backed securities strikes the lending landscape as they come due, lenders and borrowers are turning again to this product to fill their financing needs.
Fitch Ratings said there are $24 billion in loans from deals it rated that are set to mature over the next 12 months
Segment out the 2007 loans, the ones that were underwritten to pro forma income and the properties declined in value, the amount unable to refi grows to 80% (83% by unpaid balance).
The story for the loans originated in 2002 coming due in the next 12 months is a little different. Only 27% (23% by unpaid balance) are in danger of defaulting at maturity, Fitch said.
Clay Sublett, senior vice president with KeyBank Real Estate Capital, noted that 2007 was the “high water mark” for both CMBS origination volume and aggressiveness in underwriting, with large loans with high leverage and even a fair amount of financial engineering.
Many of the large loans from that vintage have already defaulted or have been restructured.
“The good news is there is quite a bit of preferred equity, mezzanine debt, b-note money out of the market right now. So there is the ability for borrowers and sponsors to go out and find money moving up the capital stack above what you’d be able to get in terms of refinance proceeds,” he said.
This is a result of the low interest rate environment which has even some of the more conservative lenders like life companies looking to add mezzanine debt and preferred equity to get higher returns. Typically, mezzanine debt lenders look for a minimum of $5 million; smaller amounts are more difficult to come by.
Adding preferred equity or mezzanine debt will help bridge the value gap, but property owners have to decide if they want to dilute their holdings—or they may not have a choice to do so due to their equity situation in the first place, he explained.
Other issues that are impacting the ability to refinance are property type as well as location. Small- to medium-size properties—especially office and retail—and those in middle America are seeing a problem.
That being said, the CMBS execution for commercial real estate finance seems to be picking up steam again.
In the first quarter of this year, Partner Engineering and Science Inc. said 7% of the orders for Phase 1 Environmental Site Assessments came from CMBS lenders, 70% came from traditional lenders and 22% from government program lenders.
These report orders, said company president Joseph P. Derhake, correlate with lending activity because they are only done when there is serious intent to finance an acquisition or recapitalize a property.
The first-quarter volume of these reports ordered by all lenders was up 13% over the same period one year prior according to Environmental Data Resources Inc. The increase, Derhake said, is a sign more capital is flowing into the commercial real estate market.
DebtX priced 54,946 loans in June with a $766.1 billion aggregate principal balance to be place into CMBS.
“Commercial real estate loan prices rose for a seventh straight month in June and have continued the upward trend of the past 15 months,” said CEO Kingsley Greenland. “Rising prices have prompted a growing number of sellers to take advantage of liquidity in the marketplace. It remains a good time to sell due to strong investor demand.”
And what might be the strongest sign yet of a return of the CMBS market,
The U.S. commercial real estate market is facing an impending wall of maturities at a time when traditional originators and underwriters are still stressed. This joint venture will provide a vehicle through which Mitsubishi and Five Mile Capital can capitalize on this opportunity, and is a natural extension of our existing real estate businesses in the U.S.,” said Konrad R. Kruger, Five Mile’s managing member.
“There is definitely life in the CMBS market,” Sublett added. In 2011, total issuance was $30 billion; for this year it is on pace to be between $35 billion and $40 billion.
A CMBS execution is starting “to become relevant” to the middle market borrower, he said. Last year, it was institutional borrowers seeking larger loan amounts that were going to CMBS; now it the middle market borrowers turning to this product, “which is encouraging.”
Life companies typically do not finance “B” properties and so having the CMBS option is important.
There has been one loan closed this year at $7.6 million; another loan was scheduled to close shortly after this interview took place in the $5.4 million range, Sublett said.
KeyBank Real Estate Capital contributed collateral to a securitization for the first time since the first time since 2008, he added. It is also considering providing mezzanine financing in a CMBS transaction, but only in situations where it would hold the senior note.
If there is a cautionary note about the CMBS market it is that the first half of last year there were signs of life and people started staffing up and preparing for growth. But in July and August of 2011 three things happened, Sublett said.
First, Standard & Poor’s decided not to finalize ratings on a CMBS deal from Goldman Sachs and Citigroup, resulting in that deal being pulled; there were political issues with raising the federal debt ceiling; and finally the downgrade of U.S. government debt.
As a result, spreads widened by about 100 basis points and the CMBS market froze up, he pointed out.
Today, the CMBS market remains vulnerable to international turmoil and upheaval in the marketplace. Small blips in Europe and elsewhere will have little effect, but major issues will once again stop this market. There are also hedging instrument questions, Sublett said.
People asked him how did the hedges perform when KeyBank Real Estate Capital contributed the collateral to the securitization. His response was that they had not been tested and so it was difficult to comment on how they performed in a calm market.
It is only in periods of upheaval that one can comment on how well the hedges performed or did not perform.
As a result right now people cannot say for certain that they are highly confident that their hedges will work as designed and protect them, Sublett said.
