Issuance of commercial mortgage bonds is falling behind the brisk pace set in 2013, but there’s no shortage of demand and terms on deals continue to loosen as the market moves toward a wave of riskier refinancings in the next few years.

The CMBS market clocked in just under $25 billion in deals this year as of May 22, compared with nearly $32 billion in deals over the same period last year, according to Trepp. CMBS deals tend to crowd the first and last quarters of the year, and 2014 appears likely to follow suit.

“It could look pretty dire through the summer, we expect, and then we’ll see a burst of origination through year end. We did expect to see low numbers, and we’re not surprised at this point in the year that volume is lower than last,” said Darrell Wheeler, senior managing director and head of CMBS strategy at Amherst Securities, adding, however, that he sees the shortfall is immaterial.

There was a burst of issuance before mid-May last year, when issuers raced to tap the market ahead of the anticipated spike in the 10-year Treasury rate, as the Federal Reserve backed off its bond-buying program.

Many of those deals were backed by sizable single loans that borrowers refinanced early, reasoning that the  fees they would pay to defease, or release the property from its lien by replacing it with government securities, warranted eliminating the risk of refinancing at maturity when rates might be significantly higher.

In fact, this year’s issuance shortfall stems partly from single-loan CMBS that would have matured this year had they not been refinanced in 2013; conduit volume is keeping pace with last year.

Borrowers have continued to defease deals this year. Among the largest such loans are a $430 million mortgage on the Aventura Mall in Miami; a $207 million mortgage on an office building at 1440 Broadway in New York City, and a $176 million mortgage on Technology Corners at Moffett Park, an office building in Sunnyvale, Calif.

Trepp’s current market intelligence suggests volume for 2014 may end up being bit higher than last year’s $86 billion.

“We expected volume to be flat to 2013—we were actually predicting $85 billion,” said Manus Clancy, senior managing director and the leader of applied data, research, and pricing departments at Trepp. “At this point in the year, we’re more or less around the same place we were last year [in terms of volume]—we now expect about $90 billion for 2014.”

CMBS volume may be down, but demand for the securities, whose coupons remain relatively attractive to fixed-income alternatives, has remained high, resulting in terms that increasingly favor issuers. “A big topic today is the quality of underwriting and type of properties going into deals,” said Marc Peterson, a managing director at Principal Financial who is responsible for CMBS investments.  “As we’re re-underwriting deals, the question at the forefront for us is whether things are getting pushed too far.”

Exemplifying deals’ increasingly aggressive terms, the $1.1 billion COMM 2014-UBS3 deal that priced last week carried a loan-to-value (LTV) ratio of 68, higher than the average low-to-mid 60’s common in the market in the last few years.  Its exposure to full term interest-only (IO) loans in the deal was 26%.  By contrast, the $1.1 billion COMM 2012-CCRE5, led by Deutsche and Cantor back in 2012, had an LTV of 64% and the full term IO portion was significantly lower, at 8%”

Beyond more aggressive deal terms in recent CMBS, loan types are also getting riskier. Peterson said that conduits are increasingly including loans for less typical property types, such as manufactured housing and senior living. Those loans aren’t problematic in themselves, he said, but nontraditional asset classes represent more of a re-underwriting challenge.

“And whenever you introduce non-traditional property types, and especially properties that have more business risk, it can potentially increase volatility,” Peterson said.

The rating agencies, however, are concurrently offsetting the greater risk with higher subordination requirements, protecting investors in the top tranches. For example, said Peterson, the COMM 2014-UBS3 deal’s triple-A tranche carries subordination of 26 5/8, the highest conduit triple-A subordination now in the market.  The double-A subordination on the deal is 18 ¼.

“So commensurate with higher risk in the loans comes higher subordination,” he said.

By comparison, he added, the COMM 2012-CCRE5 deal, led by Deutsche Bank and Cantor Fitzgerald in 2012, had triple-A subordination of 19 1/8.
Looking ahead, falling rates on the 10-year treasury combined with more aggressive CMBS spreads, although providing a coupon that’s still richer than last spring, may result once again in increased defeasance, as rate-hike fears persist. That fear is also likely to prompt borrowers to pursue refinancings later this year of 10-year loans originated in early 2005 during their three-to-six month “open periods,” when they can refinance without penalty fees.

“If I’m a borrower, and I can see a mortgage rate inside of 3.5% or 4%, which is possible right now, I’ll do whatever I can to get into a new loan,” Wheeler said.

Clancy said borrowing costs for property owners are at the lowest point in the year currently, “and these guys are saying let’s lock this rate in right now, even if it means paying some sort of defeasance charge.”  He added his sources suggest a parade of single-asset CMBS comprising trophy properties and portfolios of properties are likely to arrive before year-end.

Unsurprisingly, CMBS deals are presenting less potential upside for investors. Jeff Berenbaum, director,
CMBS strategy and analysis at

Citi Research, said the improving economic outlook made his group bullish on CMBS, especially tranches below the triple-A level, where there’s more credit risk. But in mid-May his group turned more cautious. “We feel the market is getting nearly fully priced, more fairly valued,” Berenbaum said, adding, “We’ve had such a strong run through now, and looking at where we stand on a relative value basis, say, versus corporates, we feel there’s more limited upside.”

“We feel there’s still a slight bit of upside on the triple-A bonds … if they’re at 83 basis points, which was where the most recent deal (CGCMT 2014-GC21) priced, we feel they could tighten by up to five to 10 basis points,” he said

A massive wave of CMBS deals started in 2005, and the deals’ terms got increasingly riskier through 2007, when the market collapsed. Any transactions refinancing this year from the 2005 vintage, however, are unlikely encounter refinancing challenges.

At the end of last year, Berenbaum said, Citi analyzed the refinancing likelihood of loans maturing in 2014 and 2015, looking at factors including mark-to-market LTVs and debt yields, and for 2015 loans it found 67% were likely to be able to prepay, with another 13% potentially able to prepay.

“So we have 20% that are not likely to prepay without some combination of mezzanine financing and/or equity injection,” Berenbaum said, adding, “It’s going to be less paying off than what we saw last year and probably this year, but still not too terrible in terms of the number of loans that have to raise equity or get mezzanine financing.”

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