By Scott Lynn, Director/Principal.
CMBS spreads of late have been widening out over a recent pricing exercise by the Federal Bank of New York. In late May, the Fed asked dealers to submit bids for its Maiden Lane portfolio in order to mark positions to market. Maiden Lane was created in 2008 by the Fed to facilitate the merger of JP Morgan and Bear Stearns, as well as to rescue AIG by purchasing approximately $30 billion in assets from the mortgage desk at Bear Stearns and around $50 billion from AIG subsidiaries. The $80 billion worth of loans that the Fed made will balloon in three years.
The market instead interpreted this as an attempt to unload the portfolio and began a panicked sell-off of CMBS assets, flushing the market with a substantial amount of volume that has been difficult to absorb.
While volatility is not necessarily keeping investors out of the market, it has made hedging warehoused loans far more difficult and forces lenders to quote new deals at much higher spreads. After a huge rally had driven spreads down in early April, the level suddenly blew out with the Maiden Lane debacle. The surge in AAA-rated bond spreads has led many conduit lenders to substantially widen pricing on their loan commitments. In fact, over a one month time frame, a multifamily transaction our firm has been marketing saw quotes widen from 300 basis points to 400.
CMBS lenders are very similar to herds of obnoxious grackles; it only takes one to get spooked before they all bolt. Rest assured that after seeking out a new clump of live oaks in a strip center packed with fresh cars to gleefully soil, they will all eventually come down to roost just as fast as they left and spreads will ultimately compress. In the meantime, don’t be surprised if the lender leaves the spread in your Term Sheet blank. They will fill it in at closing with a number that is profitable to them. While this may seem contrary to the more orderly and known quantity of CMBS 1.0, it is the harsh reality of the new and still evolving securitized market in a time of economic uncertainty and peril. Consider yourself lucky it is even there for you to take before the indignation of being re-traded overcomes your sensibilities.
Default risk, AAA-rated spreads and the oversupply of CMBS bonds are not the only things driving volatility in spreads. The economic conditions in the United States and the European/Greece issues are making investors/bond buyers considerably more risk-averse. As a result, a number of commercial mortgage-backed securities conduits are reportedly holding off on new originations due to the extreme volatility in trading over the past month. With rates now rubbing against 7 percent, CMBS lenders have almost overnight become even further weaker alternatives to portfolio lenders and the few banks that are making loans, endangering their very existence.
With this increased volatility in the market, lenders will be forced to reduce the size of the pools of mortgages they take to market. In the heyday of the CMBS market, large loan pools were the hallmark of securitized lending. Unlike the insurance companies, where large loans had to be funded by more than one insurer, the securitized lenders could unilaterally fund very large loans. Now, volatility in spreads is forcing securitized lenders to come to market more often in order to hedge against spread risk. Without stabilized pricing in the market, lenders are unable to cobble together the large loan pools as they have done in the past. This also makes it more challenging to prudently diversify the asset pool. CMBS lenders can no longer afford to be the high end chefs in the securitized kitchen they once were when it came to piecing together the right flavor profile of a securitization; they must now become short order cooks slinging hash, grits and whatever mystery meat happens to be left in the fridge as quickly as they can before the health inspector shuts them down. If you are the diner, you would be well advised to eat whatever it is they are serving without asking too many questions or complaining about the food.
Want to learn more about this, feel free to contact Scott Lynn, Director/Principal.