Standard & Poor’s said last year that the CMBS market was experiencing a major correction, but that it had an important role to play in the commercial real estate sector.
In a report released today, the rating agency has reaffirmed this belief and stated that, after nine months and five new transactions, the CMBS market seems to be “slowly coming back to life.”
According to S&P, market participants seem to be implementing new provisions for transactions, possibly in an attempt to balance investors’ preferences with CMBS loan borrowers’ practical and economic requirements.
For instance, three of the five deals that have come to market this year had only one borrower. These deals are DDR I 2009, BALL 2009-EDG, and JPMCC 2009-IWST. The other two transactions, RBSCF 2010-MB1 and JPMCC 2010-CI, had more than one borrower, according to S&P.
S&P also enumerated several trends in the CMBS market that have been observed since the end of 2009.
According to S&P, issuers have used the bifurcated interest rate option, which allows them to monetize the excess spread that they generate by originating loans and selling bonds.
Until recently, S&P said that 100% of the IO securities that issuers included in CMBS transactions were usually triple-A rated since those bonds were at the top of the interest waterfall or they were first in line to receive scheduled interest payments.
However. S&P revised its methodology for rating IO classes back in April 2010. Its ratings are now based on both the IO securities' payment priority and the rating agency's view of the underlying assets' credit quality.
Based on these revised criteria, issuers are increasingly using a bifurcated IO class, which includes a senior triple-A-ated piece and a junior, unrated piece, in CMBS deals. Issuers have been doing this also for non-S&P rated transactions such as the JPMCC 2010-C1 offering.
S&P also noted that retail properties have dominated recent CMBS, which the rating agency attributed to a simple function of supply and demand.
"In our opinion, because there are fewer creditworthy borrowers left in the market today as a result of the credit crisis, there is generally a shortage of low–leveraged, stable assets that are suitable for securitization," S&P analysts wrote.
Stricter underwriting and loan structuring standards have also become more common, and tighter cash management appears to be playing a key role in new transactions, the agency said. S&P noted, however, that protections for junior and senior bondholders appears to be more aligned.
S&P said that nine months ago, its analysts predicted that new CMBS deals would have lower all-in leverage, little or no added debt held outside the trust, 25- or 30-year amortization schedules, as well as more conservative loan underwriting. For instance. lenders are now utilizing higher vacancy assumptions and in-place rents. The recession seems to have taken a considerable toll on CMBS borrowers and investors, given the recent track record and performance of CMBS transactions that were issued from 2005-2008
"We believe this has clearly affected the key variables of commercial mortgage loan underwriting, including appraisals (higher capitalization rates), property-level cash flows (property cash flow levels are typically below those seen two to three years ago), and underwriters' projected cash flow, which, for the transactions that we've rated, have generally reflected the in-place cash flows with minor adjustments," analysts wrote.
The rating agency said that tighter cash management seems to be playing a key role in new deals.
Analysts added that with recent vintage CMBS collateral, certain features including lockbox accounts, hard cash management, and cash flow sweeps,are aimed at offering investors more protection from potential credit losses and less risk of an interruption in their interest payments.
The strictest provisions were applied to the three recent single-borrower transactions, while the multiborrower deals have featured a range of cash management provisions, S&P said.