Judging by a variety of metrics, the market of commercial mortgage-backed securities turned in a fantastic performance last year: estimates for 2013 put issuance at, or near, $90 billion, an 86% leap from 2012; delinquencies were on track to drop below 6% in December from 7.99% a year ago, as gauged by Fitch Ratings.
But recent reports have pointed out that underwriting standards may be getting sloppy while LTVs inch higher. And it is doubtful that a few of the engines that propelled a stellar 2013 — most notably, a robust recovery in property prices and historically low interest rates — will have as potent an effect in 2014.
All the same, many players argue the market is set for another year of issuance growth paired with low delinquencies, as we are still a good away from the overly relaxed approach by dealmakers that prevailed at the height of the boom. Consensus projections are for a 10-15% growth in CMBS issuance volume for next year.
Many see this exuberance as entirely rational.
“We’re slowly trending towards higher leverage ratios and lower DSCR (debt-service coverage ratio) but we’re nowhere near where we were in ’06 and ’07,” said Joe McBride, research analyst at Trepp.
He added that in 2007 the average DSCR was 1.4x and in 2013 it has, so far, averaged 1.9x. “We’re still covering almost two times what you owe on loans right now.”
LTVs are, indeed, rising. In a video posted Dec. 4, Fitch Managing Director Huxley Somerville said that the agency’s average LTV on CMBS deals was currently 100%. The default curve, he added, “steepens dramatically” once the figure tops 100%.
This, on the other hand, has pushed the agencies to require more enhancement. “If underwriting declines further into 2014, I would expect to see significant increases in credit enhancement,” Huxley said.
While underwriting standards declined through 2013, he added that about now they’re at 2005 levels.
An example of LTVs heading up was JPMBB 2013-C17, a $1.08-billion conduit deal backed by 64 loans that are, in turn, secured by 72 properties. JP Morgan Securities, Barclays Capital and RBS Securities led the transaction. It priced on Dec. 19.
The loans range in size from $2.1 million to a $120 million mortgage secured by Jordan Creek Town Center, Iowa’s largest shopping complex covering two million square feet. Iowa’s largest shopping complex with a leasable area of 1.34 million square feet, according to the website for its manager, General Growth Properties.
Lenders in the deal include JPMorgan Chase Bank, National Association; Barclays Bank; General Electric Capital Corp.; Redwood Commercial Mortgage Corp.; and RAIT Funding. JPMorgan and Barclays combined provided nearly 77% of the collateral.
Fitch, which rated the multi-tranche deal, gave it a stressed loan-to-value of 106.7% and a DSCR of 1.11x, both figures that are veering away from the safer norm of earlier in the year.
Fitch LTVs averaged 97.2% in 2012 and 102.1% in the third quarter of 2013.
Also rating the deal is Kroll Bond Ratings, which calculated the pool’s LTV a more generous 101.8%, the highest among the 19 conduit CMBS Kroll rated over the six months ending November 2013. That cluster averaged a 96.3% LTV.
Kroll pointed out that its LTV value is generally lower than the appraised value. Indeed, the issuer itself calculated an LTV of 66.3%.
One loan in particular is skewing JPMM, the third largest, secured by The Aire, a multifamily, 310-unit luxury residential building on Manhattan’s Upper West Side. The amount of that loan in the trust is $90 million. Without that one, the LTV would be a lower, but still appreciably higher than the 2013 norm, at 104.6%.
Fitch found that the pool could withstand a 48.97% decline in value and an approximately 28.45% decrease in the most recent actual cash flow prior to experiencing $1 of loss to any AAAsf’ rated class, consisting of super-senior 10-year notes. With a 30% credit enhancement, this tranche priced at 95 basis points over swaps, only a couple wide of recent comps.
The two largest super-senior tranches are $210 million (A-3) and $319 million (A-4).
The stricter requirements of the ratings agencies and their warnings of laxer times ahead is another factor that is lending some comfort to investors. The prevailing view is that the agencies are more vigilant this time around.
Standard & Poor’s expects the credit quality of CMBS issued in 2014 to head south as lenders grow more competitive and B-piece buyers become more accepting of transactions with poorer metrics.
But higher LTVs are not the only deal feature that tells a story of looser standards. The selection of loans to each pool may not be as rigorous as it was in 2012 or early 2013.
In an early December release, Fitch pointed to two securitizations — GSMS 2013-GCJ16 and Morgan Stanley BofA Merrill Lynch Series 2013-C13 — that had loans removed shortly after pricing. In the former case it was the fifth largest loan in the pool; in the latter, the ninth largest.
The agency said these reversals could be a sign of understaffing at origination teams that cannot keep up with the heady growth of the business this year.
Understaffing has another dangerous side effect as well — teams might not gain an in-depth knowledge of local real estate conditions. This creates blind spots in terms of the rise of potential competitors against the properties securing CMBS loans.
But these concerns are not strong enough to trip up the market’s intense growth.
The Fed-engineered backdrop of historically low interest rates has gone a long way in helping maintain the momentum. “Loans that are coming due from ’06 and ’07 [have rates] in upper fives and low sixes, and the ones getting done are in the mid fours,” McBride said.
With the tapering having begun, rates quite this low are not going to hold but many believe they will remain low enough to keep fueling growth.
In late December article in ASR sister publication National Mortgage News, the CEO of Cantor Commercial Real Estate, Anthony Orso said CMBS issuance could actually reach $125 million next year. This is on the higher end of projections but shows the strength of optimism in the sector.
nd despite the looming risks, performance remains impressive. In mid December, Standard & Poor’s noted that the dollar amount of delinquent loans has been declining for the past two years.
“Underlying property fundamentals, such as vacancy rates, indicate that conditions are improving for property owners,” the agency said, adding that even its downside scenario, potential downgrades for CMBS would likely be limited to tranches in the capital stack below triple-A.
The greater comfort felt by investors — and not only the triple-A kind, as the crowd of B-piece buyers grows — should push the issuance mix between conduit and single loan deals further towards the former, according to Trepp’s McBride.
This would signify a shift towards the historical norm and away from 2013, when single loans made up an unusually high share, at nearly 45% the total. “Coming out of 2012 when we started to get moving — investors were more comfortable doing single asset deals because they’re less complex,” McBride said.
The really in real estate prices in many parts of the country should also hold, observers say.
“Commercial property prices will remain stable over the next few years, solidifying the price recovery that has taken place since the 2007 financial crisis,” Moody’s Investors Service said in its Dec. 9 global structured finance outlook, adding that this will support the CMBS market.
The agency sees the sector as a beneficiary of the country’s strengthening economic expansion.
But further down the road, Moody’s expects the rise in long-term interest rates to spur issuers to loosen debt-service coverage and, consequently, reduce credit quality.
And, then of course, there is the refinancing risk represented by the $346 billion in CMBS loans slated to mature between 2014 and 2017.
In 2014, the maturities are about $40 billion — easily dealt with, given the year’s issuance forecast — but they escalate to a peak of $113 billion in 2016.
And two years from now borrowing is likely to be a lot more expensive.