Flashback to a year ago at the Commercial Mortgage Securities Association's (CMSA) June conference. Outgoing CMSA President Kent Born was hopeful that the RMBS subprime crisis that was spilling into CMBS would result in a stronger and more sustainable market.
Meanwhile, six months ago at CMSA's investor conference held in Miami, the key phrase amidst a very dire tone was challenges and opportunities, although participants were acknowledging that the market was weighted more toward the challenges, which included a crisis of confidence, rising delinquencies and a period of lax underwriting, to name a few.
So are we there yet - stability or correction? That was the question put forth at CMSA's 14th annual conference held in New York City last week.
Like little kids in the back seat eager to be there already, the housing turmoil, economic slowdown and tight credit conditions are keeping the "timing of getting there" uncertain for the CMBS market.
At the Miami conference earlier this year, some return of confidence was expected for the second half of 2008, which was partly based on tighter underwriting standards included in the new deals. This improved confidence brought back investors who were subject to mark-to-market accounting given that the risk for write-downs could have been reduced. Supply was projected at over $100 billion.
Since the Federal Reserve rescue of Bear Stearns in March, the markets have calmed down some, but they remain very jittery.
Meanwhile, CMBS supply has been nearly nonexistent. Conduit issuance will likely be just over $10 billion when June closes out, assuming the Banc of America Commercial Mortgage (BACM) deal gets done.
Estimates for the year have declined significantly from original forecasts as well. So as the second half of the year gets underway, issues that were seen as being closer to a resolution still seem to remain a distant possibility.
Dealing with the Impact
Based on comments from Allstate Investments Senior Managing Director M.W. Sam Davis of the firm's real estate investment group, it would seem the market currently remains in a correction mode. Speaking from his own experience at his company and his interpretation of the current environment, he noted that Allstate's volume was down significantly, and the firm was not lending as much as it would like.
A couple of reasons behind the slowdown are corporate concerns regarding lending in this environment and the economic outlook. The uncertainty surrounding these discourages investors from holding real estate, Davis said, especially as portfolio holdings are underwater. He added that pricing volatility was just so unexpected, and with no end in sight regarding volatility, it makes it even that much more difficult to add to their exposure. In addition, investors are not inclined to take on the risk of buying it either.
Loan demand has also been limited as life insurers are much more conservative right now, he said. Previously, they would make loans at 75% LTV; now it is closer to 65% LTV. Commercial property values have also declined, he noted, with the general exception of the top-tier properties, although they are not totally immune.
He also said that on a global level, institutions will be holding more cash for liquidity purposes over the next couple years as a result of the economic uncertainty. Another industry attendee remarked that he too believed that there has been a permanent repricing of risk, and he didn't expect it would ever come back to what it was.
Lisa Pendergast, a managing director in CMBS research and strategy at RBS Greenwich Capital, said that the current conditions and outlook are not how it looked on the horizon back in January.
At that time, triple-A super senior 10-years were trading at 85 basis points over swaps, a level where loans could still be originated somewhat competitively. As a result, the supply outlook for 2008 on average was about $80 billion to $100 billion, though down substantially from the $229 billion issued in 2007.
The ability to use conduits, however, became just too expensive as spreads blew out to 315 basis points over swaps in March as confidence evaporated on increasing credit crisis headlines, and remains so, even though spreads have improved to 157 basis points over swaps.
As a result, Pendergast believes issuance this year may reach $25 billion. Currently, the odds are good that there will be no more issuance after the upcoming BACM deal until the fall.
The severe drop in supply, though, could be a blessing in disguise, she added, as it is contributing to a pickup in demand for new issues and inventory. There has been some improvement in confidence from various sources, including stronger underwriting, ratings guidelines and better credit enhancement, as well as the Fed's initiatives that all contributed to enough confidence to actually report levels on the triple-B tranches in the last Merrill Lynch deal. Investors are also starting to focus on CMBS fundamentals such as manageable (and low) delinquency levels and supply being kept in check, factors not found in the RMBS sector.
Also, unlike subprime, Pendergast added that CMBS dislocation has been a factor of mark-to-market accounting and not credit quality related.
CMBX volatility also had a hand in the spread widening earlier this year, in part on the lack of pipeline. At this time the pipeline is nearly empty, although Pendergast does not anticipate an event similar to earlier this year. She said that there's a much calmer tone in the market and that participants are tuned into fundamentals again. Spreads, however, will still be buffeted by headlines and rumors, but the impact of the CMBX is seen as exerting a lesser influence compared with before.
Regarding the rollout of the next CMBX index (6), it will likely not happen this year given the lack of deals. There could possibly be one created when there are at least 15 deals available to include, she said.
Back at the January conference, participants commented about CMBS getting painted with the subprime brush. While CMBS has seen some deterioration, the sector is much more fundamentally sound, although certain sectors will be impacted by the economy to some extent. Alan Todd, executive director at JPMorgan Securities, noted such that sectors include retail, multifamily and hotels. Also, certain areas, such as Florida and Nevada, were overbuilt and will need to be worked through.
The overall conference tone was much more subdued than the previous two. Attendance was off by about 1/3 versus last June. In addition, there was a heightened sensitivity to information reported. The press was not allowed to attend the general sessions, for example, which pretty much encompasses the entire conference.
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