Even with reports of JPMorgan Chase planning to sell $1 billion of CMBS — the biggest deal this year — issuance in the sector is still far below 2007 levels.
Five transactions pooling commercial property loans have come to market in the past six months — and the deals are dramatically different from those assembled before the credit crisis.
Some of the changes have to do with the mix of collateral and the way lenders are willing to finance them. The new crop of deals is backed almost exclusively by retail properties, making the pools far less diverse than in the past.
For example, dealmakers at JPMorgan Chase are starting to market a $660 million offering backed by retail properties owned by a single borrower, Vornado Realty Trust. The properties are concentrated in the Northeast; a little more than 70% are in New Jersey alone.
At the same time, the latest deals consist of fewer, larger mortgages because lenders just do not want to tie up their balance sheets.
Other changes are coming at the behest of investors, many of whom lost big on some of the highest-rated securities of 2007 and 2008. They are demanding more disclosure about the pools of collateral, and they are asking for a better alignment of their interests with those of the other parties in these transactions.
"Investors are laying down a marker" before committing money, said Brian Olasov, a managing director at McKenna, Long & Aldridge. "They are making certain demands from the underwriters in the governance of deals and the relative rights of investors and insiders to CMBS trusts."
For example, at least two deals, including the one backed by loans to Vornado, give investors in the highest-rated tranches the power to direct and replace special servicers (the companies that handle troubled loans).
Senior bondholders, who are typically the last to suffer losses, traditionally have been passive investors, and the junior-most bondholders, which often are affiliates of special servicers, have had control of the workout or liquidation of defaulted loans.
When loans go bad, these two classes may be pitted against each other — senior investors might want to foreclose on a property to get some of the principal back, but junior investors may have an incentive to keep the debt outstanding.
Since 'AAA' tranches are the most senior and receive the least risk compensation, "this is exactly how CMBS should have been structured all along," said Amy Levenson, a managing director at NewOak Capital.
Levenson said she would like to see this taken a step further; deals should require both the borrower and the underwriter to keep some "skin in the game" by holding on to a deal's riskiest pieces.
This has already happened in some 2010 deals that lack a subordinate B-tranche, possibly because the underwriters could not find a buyer for it. Recent deals also contain features designed to protect investors from credit losses and reduce the risk of an interruption in interest payments.
In a report published this month, Standard & Poor's said the strictest provisions generally can be found in single-borrower transactions, requiring the borrower to direct all revenue received from the mortgaged properties into a "lockbox" account. For example, under certain circumstances, the tenants of a property backing a CMBS deal might pay their rent directly to an account accessible to lenders.
Single-borrower transactions also have features designed to ensure that the interest and principal payments that bondholders receive are bankruptcy remote, or out of the hands of companies that file for protection, S&P said. This has been a concern for investors since an April 2009 bankruptcy filing by the mall owner General Growth Properties raised questions about whether a corporate bankruptcy could affect a CMBS transaction.
Olasov said investors also are demanding features such as voluntary investor registries that make it easier for investors to assemble and communicate with one another, caps on the fees charged for servicing delinquent loans, and special websites where they can get special servicer reports and requirements.
Deals have historically allowed some "insiders," such as special servicers, to bid for and acquire distressed loans at market value, as certified by the trustee, he said, but some investors, who assert that trustees are not set up properly to monitor market values, want these loans to be auctioned.
Investors are demanding these safeguards even though underwriting standards are much stricter than they were at the peak of the bubble that inflated from 2005 to 2007. Market participants say commercial mortgages backing today's deals typically have loan-to-value ratios of 60%, compared to 75% or higher on loans securitized in some earlier bonds.
Barbara Duka, an analytical manager for new issuance of U.S commercial mortgage-backed securities at S&P, said some loans in recent single-borrower deals have LTV ratios in the 51% to 59% range.
By giving investors what they want, underwriters have drawn interest to an asset class that was all but dormant last year; this year's deals have been oversubscribed two or three times. Still, market participants expect no more than $10 billion to $15 billion of deals this year, a far cry from the $230 billion sold in 2007 and a drop in the ocean compared with the several hundred billion dollars of commercial mortgages that need to be refinanced each year.