By Charley Babb
CMBS issuance for the first quarter of 2016 was roughly half of the production for the same period in 2015. This has been counter-intuitive for most of us in the commercial real estate lending community as reasonably positive US economic performance combined with significant CMBS legacy maturities should have resulted in 2016 outpacing last year’s production. Many experienced CMBS borrowers are asking “what is going on here?”
In contrast to the previous cycle when aggressive underwriting led to a “bubble”, this time around there are other factors contributing to the instability and uncertainty in the market that perplexes many of our clients. In December, we saw the culmination of fourth quarter spread widening to the point where various participants were unprofitable on their originations. This has led to a reduction in the number of CMBS lenders to under 30 at this point from over 45 at the peak in 2015. Mid-sized origination shops are being squeezed out by larger institutions that are securitizing more frequently.
CMBS bond buyers continue to impact pricing as they weigh the relative values of widened spreads on corporate bonds vis-à-vis CMBS issues. While senior tranches are pricing close to levels that were seen last August, bonds lower in the capital stack continue to lag and the credit curve remains steeper than last summer.
Further uncertainty on the part of issuers lies ahead as the environment becomes more regulated. Regulation AB, Basel III, Dodd-Frank and risk sharing rules will definitely impact the market. You say you don’t know what all of those are; simply read them as “more government regulations intended to ‘safeguard’ the consumer, but resulting in making it more expensive to borrow money.”
As a result, borrowers who have traditionally looked to CMBS lenders to finance or refinance their properties have elected to look to other capital sources in the past six months. Re-trades on pricing and terms have led to a preference for certainty of execution over leverage. Life insurance companies, banks, and private lenders have provided debt in the Q1 2016 that would have been financed in the CMBS market during the same period last year. There is a catch, however. Some market observers have noted that these alternative sources to CMBS may reach their respective capacity for debt issuance by the end of the third quarter. This may set in motion a potential liquidity crunch late in the year.
Borrowers facing Q4 maturities may be forced to settle for a CMBS execution should lack of liquidity from other sources turn out to be a reality. This is likely good news for a lagging CMBS market as pricing should be higher leading to a return to profitability and hopefully more certainty of execution. That said, fewer options for borrowers will likely provide less favorable terms for them at that juncture.
In conclusion, if a borrower has flexibility in their timing, now might be a better time to access the capital markets rather than later in the year.
Metropolitan Capital Advisors seeks to assist their clients with their commercial real estate financing needs. We welcome the prospect to evaluate your new acquisitions and development opportunities.
The author, Charley Babb, is a Senior Director and Principal in the Denver office of Metropolitan Capital Advisors. Contact Charley Babb at firstname.lastname@example.org