While the RMBS market remains down and most definitely out, CMBS has struggled to set itself apart as the "safer" mortgage investment.
But, credit fundamentals aside, any type of mortgage remains a dirty word for all market participants, and CMBS issuance is not coming out of the current crisis unscathed.
Over the past two weeks, all three major rating agencies have published a slew of reports centered on current CMBS performance and expectations for new issuance. The numbers are bleak.
Earlier this month, Moody's Investors Service lowered its outlook for 2008 CMBS issuance to $35 billion for traditional conduit issuance, based on the rating agency's current deal flow and what bankers and originators have said they have in the pipeline. This is down from a record $230 billion in 2007 and a drop from Moody's original projections, which were estimated to be $100 billion for the year.
New deals have been relatively sparse. There is approximately $9 billion in issuance already out in the market, and another $1 billion in the pipeline, said Alan Todd, executive director and head of CMBS research at JPMorgan Securities.
Several factors have contributed to the issuance drain. Originally, banks were limited in the risk that they could hold on their balance sheets. While this constraint still exists, the problem has grown into one of profitability, or lack thereof.
As investors are demanding wider spreads on CMBS deals, banks' conduit shops cannot originate loans to make a profit in the same way they did in the past.
"Given where securitization exit levels are, the whole loan break-even spread for a Wall Street conduit is about swaps plus 280 basis points, and banks and life insurance companies are quoting it at swaps plus 200 or 225 basis points," Todd said. "This is not yet competitive."
Up on Pricing
However, the market is relatively optimistic because pricing, although still historically wide, has started to pull back in. "Bond spreads have begun to stabilize at the top of the capital structure and as they continue to tighten, conduit lenders will become more competitive," Todd said, noting that origination volume should start to trickle back in the third quarter with issuance following in late 2008 into 2009.
Stronger fundamentals have helped keep the industry afloat during weak economic conditions, especially given the increased focus on underwriting standards for conduit loan issuance. For example, loans closed year-to-date 2008 had Moody's loan-to-values below the 100% mark, a level not seen since early 2005, the rating agency said.
Delinquencies also remain historically low, despite weakening retail and multifamily sectors.
In the Fitch Ratings April loan delinquency index released last week, U.S. CMBS delinquencies rose by two basis points to 0.35% in April. This increase was primarily a result of a $127 million multifamily condominium loan that is expected to be brought current, the rating agency said. Had this loan not been delinquent, the index would have remained flat at 0.33%. The rating agency reported that there are 360 delinquent loans out of approximately 42,000 loans in Fitch-rated transactions.
More Reward for Risk
But, the CMBS market has also seen rising cap rates, as critical investors are reassessing the risk premiums in these transactions. At the end of January, cap rates were up 37 basis points in the apartment sector, 59 basis points in the industrial sector, 17 basis points in the office sector and 24 basis points in the retail sector, according to research from JPMorgan.
"In an industry that is based on cash flow like commercial real estate, you are talking about taking a percentage of value right off commercial real estate, generally," said Nick Levidy, managing director at Moody's.
Not helping this are pricing declines, which have made their way over to the commercial real estate sector with prices dropping 2.3% in March, according to the Moody's/REAL Commercial Property Price Indices. Office sales volume is down 60% in 1Q08 from 1Q07, while retail dropped 58%. These two sectors made up almost 60% of all loans securitized in 2007, JPMorgan said.
However, there are still trades being made, and balance sheet transactions might be able to mitigate the drop in issuance projections, several market participants said.
"Triple-A bonds are still selling fairly well, and to that extent it is a way that banks can manage their balance sheets to offload some exposure to CMBS," Levidy said.
Other ways that banks are cashing in on their commercial real estate loans is by converting them into CMBS certificates, which will provide capital charge relief from regulators since bonds are perceived to be more liquid assets. Banks can also borrow against the triple-A bonds by using the Federal Reserve's Term Auction Facility.
But not all market participants thought this was a profitable avenue for banks since triple-A paper is the only part of the capital structure that is garnering significant investor interest.
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