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In this edition of Capital Insights, we dive into what is causing the choppiness in the CMBS markets, and alternatives where borrowers are heading to refinance pending loan maturities. As well, we consider how these events could affect the capital markets in the second half of 2016.
Choppiness in the CMBS Markets
CMBS issuances year-to-date as of February 12th have been a paltry $6.5 billion, compared to $13.7 billion for the same time period in 2015. Given the robust (or at least steady) flow of positive national economic employment and spending figures, we ask – why are CMBS originators pumping the brakes?
Unlike the last cycle in which lax underwriting precipitated the initial slowdown in the CMBS market, in this case there are various external factors that are making it hard for CMBS lenders to price new loans competitively and commit to terms prior to closing.
First, the number of CMBS lenders has shrunk. As spreads continued to widen through Q4 2015, various players missed their break-evens in the December 2015 securitizations, and were pushed out of the market. The insight from our recent survey of CMBS lenders is that the market will “barbell” as mid-sized origination shops are squeezed out by large originators that are securitizing on a frequent basis, and niche lenders that are bound to specific product types or geographies. The focus is now on execution, after a volatile Q4 in which the spread on benchmark CMBS paper blew out, squeezing profits and causing higher spreads on new loans.
Second, CMBS bond buyers are still finding their feet in the New Year. Spreads for the “rated” tranches of the recent CMBS securitizations are being pushed wider as these bond buyers look to the relative value of widened spreads on corporate bonds and demanded the same (or higher) returns from CMBS bonds. Had this just been typical “noise” in the market, CMBS spreads would have pinched back in or stabilized at a wider spread, but in this case the pending regulatory requirements (set to take effect in December 2016) for the “unrated” B-Piece of the CMBS securitizations is leading to a greater uncertainty in nascent business model of CMBS 2.0, as CMBS originators and private funds reconfigure the capital used for B-Piece purchases. The new regulations will require CMBS originators to keep a stake in their originations and hold the risk on their balance sheets for 5 years in an attempt to discourage risky lending and keep their “skin in the game”.
As a result, CMBS originators are treading cautiously – pricing loans with enough “cushion” and regressing to primary markets. Subtle innovations include a “spread lock” mechanism for large loan borrowers, as well as, lenders raising capital to acquire their own “unrated” B-Piece tranches in separate vehicles. Borrowers who would traditionally look to a CMBS refinance are looking elsewhere, as re-trades on pricing and terms in the turmoil of year end have now readjusted their expectations on leverage and focus on certainty of execution.
CMBS Alternatives / Liquidity Crunch in Late 2016
Dekel Capital recently conducted a comprehensive survey of the banks, debt funds, and life companies that are soaking up the pending loan maturities that one year ago would have gone to CMBS. Market sentiment is positive as debt funds are seeing more business as borrowers look for better execution and/or 36 months of runway to decide to either sell the product or place fixed rate pricing on it. Additionally, there are life companies with products pushing leverage to 70% LTV. These newer products can rate lock at application and are priced competitively against CMBS pricing.
Market input is that the 2016 lending capacity for debt funds, life companies, and banks may be deployed by later summer, leading to a potential liquidity crunch should deals come up against a pending loan maturity. The equity groups we speak with on a regular basis have echoed this sentiment, modeling their own exit scenarios and are shifting away from investing in vacant office conversions or retail repositions involving a significant period of downtime, with the focus in-place cash flow.
Capital to Highlight:
Dekel Capital has identified a Life Company with ample capital to deploy for long-term fixed rate loans. The loan program can push leverage to 70% LTV, fixed or floating rate terms are available at competitive pricing.
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If you have a pending transaction in need of financing, contact a member of the Dekel Capital executive team to discuss how we can assist in finding the best capital source for your needs.