Casting a cloud over the CMBS sector for 2012 is an overhang of about $55 billion in CMBS loans that are coming up for refinancing. Industry participants are watching to see how these loans will fare. These mortgages form part of an estimated total of $365 billion in commercial real estate-backed loans coming due in 2012, according to CMBS data provider Trepp.
At issue is the question of whether borrowers will be able to come up with any additional equity they require to refinance loans made during frothier times, considering that commercial real estate properties have seen considerable declines in value over the last few years. Harris Trifon, Deutsche Bank Securities' global head of commercial real estate debt research, expects that some borrowers will be able to come up with the additional equity, while others won't, considering that "It all depends on the state of the world and how commercial real estate is going to fare as a function of that."
As for the question of where the money for the refinancing will come from, as Jack Cohen, CEO of Cohen Financial, sees it, the issue is not so much about the availability of financing as it is about who will take any loss associated with the properties. "If people are willing to take the loss and the trades happen, there's capital there," Cohen said."The issue is not capital shortage; it's a remarking of the value that isn't happening. Once it does, there's more than enough capital in the system to support the commercial real estate business."
Additionally, David Oliner, a partner with Dune Real Estate Partners, an opportunistic investor in distressed real estate, expects that a combination of new equity from sources such as Dune, and reinvestment in deals by current investors, along with lending by banks, life insurance companies, Fannie Mae and Freddie Mac, will all help with the refinancing efforts.
CMBS is likely to be a competitive financing source in the case of assets that are not sought after by life insurance companies and banks."CMBS has a place for the execution, for people that want more proceeds, who can afford to pay more in yield and who either have a funkier product or a funkier location," Cohen noted.
Where Cohen sees a gap in the CMBS financing vehicle is in a lack of demand for the middle stacks of CMBS securitizations. "The real issue for CMBS is permanent capital. The amount of buyers to invest in the middle of the stack is thin. There's plenty of 'B-piece' buyers. With the public market there's plenty of super-duper tranche triple-As, but the middle of the beast is weak," he noted. Cohen expects that any shocks to the economy will cause prices to widen for this middle stack of CMBS if bond buyers are scared off.
To the extent that the economy at least muddles along in 2012 and gets healthier, real estate values will benefit as demand for commercial space goes up. However, if further economic deterioration sets in, borrowers and lenders will have to face a reckoning in terms of taking a loss on their real estate holdings.
While the anticipation that the commercial real estate sector would be the next shoe to drop - following the residential mortgage crisis - hasn't played out yet, the sector is not completely out of the woods.
According to Oliner, the shoe has been dropping all around, only it's happening slowly and over a period of years, rather than all at once. Commercial real estate values are down nationwide, but typically this is not of consequence until a trigger occurs, such as a tenant rollover that results in reduced rent. Or it could be an inability to refinance after the loan matures.
Oliner noted that special servicers are less inclined to provide an easy modification today than they were two or three years ago."All of us heard the term 'kick the can down the road' two or three years ago," he said. "Those were basically extensions. Special servicers are still willing to provide modifications, but they're much more inclined to require fresh capital from the sponsors in order to obtain them."
Trifon pointed out that as loans that have been restructured come up for refinancing, properties backed by the modified loans are likely to be less competitive with other properties in terms of attracting tenants.
"We're concerned that as these restructured loans begin to come up for maturity in 2012 and 2013, there's a potential issue in the value of the underlying assets getting eroded because the owners are still locked into these overlevered debt structures. So they won't necessarily be able to be competitive with properties that are not in terms of getting tenants. It's a competitive leasing environment," Trifon noted.
Properties that are less competitive are also at higher risk for delinquencies and credit events. Oliner is watching for such distressed debt opportunities in 2012. The flow of loans into special servicing, which had started to slow down a bit in the first half of 2011, saw an upswing in the second half, following the market issues that cropped up in the summer, he said.
"What we have heard is that the flow in the special servicing platforms has grown by and large over the last three or four months, after plateauing and declining a little bit. I think that based on what we've heard from special servicers, this pace will likely continue through next year," Oliner said.
Trifon expects that, even with a rise in the number of delinquent loans and transfers to special servicing, CMBS delinquency will be largely unchanged from current levels of about 9.5%. He is most pessimistic about the outlook for office and retail properties, since he expects a less than robust recovery in job growth and consumer spending for 2012.
CMBS to Strengthen?
As for estimates about 2012 CMBS issuance, expectations are for at least $35 billion in non-agency issuance, compared with 2011's approximately $30 billion of issuance. In fact, there is already more than $8 billion of supply in the 2012 pipeline, according to Deutsche Bank. And while regulatory issues such as the impact of the Dodd-Frank risk retention proposals and Basel III capital requirements could have an impact on CMBS issuance in the future, Cohen believes that any potential impacts from Dodd-Frank are getting baked into deals, considering that everyone knows the regulations are coming.
One factor that could help make for increased issuance is the availability of a hedging tool in the form of the TRX II. Among other things, this gives conduit lenders a hedging mechanism to hold loans on their books while they aggregate them for securitization.
"TRX II has been created because the hedging has been problematic. Hedging your pipeline and hedging against the market risk that we saw has proven to be impossible," Cohen said. The availability of such a hedging tool is especially likely to be beneficial if the market volatility seen in 2011 continues into 2012, considering that there are still unresolved issues relating to the European sovereign debt crisis as well as the ongoing political wrangling in the U.S.
In case there are any adverse consequences from the European debt crisis, there could be bad fallouts for CMBS, as well as for the U.S. economy at large. "CMBS will be hit harder than other products because CMBS has a yield to the borrower that is a compilation of a lot of different spots on the curve. I think it will blow spreads out, people will delay securitization and there will be less issuance," Cohen stated.