NEW YORK - At the Commercial Mortgage Association's Eleventh Annual Convention held here last week, participants focused on the evolution of deal structures, which has been a major theme in the CMBS market over the past year.
Participants at the panel called The Man Behind the Curtain - Who's Structuring This Deal Anyway? said that competitive pressures have been the single driver of structural innovation in CMBS. There has also been a clear "chipping away" in loan structure with LTVs rising, amortization in loans diminishing - even in hotel collateral - and loan pricing dramatically changing. Panelists added that for the right pricing, borrowers could now get a "detailed menu" of loan characteristics specifically tailored to their needs. For instance, panelists said that many floating rate features are now being structured into fixed-rate commercial mortgages.
Additionally, on the bond side of the equation, running opposite to the recent growth of pari passu notes - which involves splitting a loan into several pieces and placing those pieces in separate deals - individual pools are now becoming larger. This has minimized the need for further diversification and risk mitigation, as this phenomenon has reduced a typical pool's exposure to any specific loan to 3% to 5%, panelists said. And with these bigger pools, market players are becoming less concerned with leverage, so "they just throw in whole loans into deals," one panelist said.
One particular innovation that panelists focused on is the evolution of super-senior tranches - touted as the CMBS equivalent to CMOs - which has led to what panelists called "the customization of the triple-A." These super seniors originate from reverse inquiries by investors who pushed back on 10% to 12% subordination levels. However, Patrick Mattson, a vice president from Morgan Stanley, said that these super-senior tranches did not just evolve from credit considerations, as these classes also sprung from concerns that the current loan composition in deals could lead to extension risk, citing current IO loan statistics. In 2004, IO loans would typically make up less than 10% of pools, rising to 30% to 40% currently.
Jim Duca, managing director at Moody's Investors Service, said that in terms of these super-senior tranches, the rating agency is not really concerned about the triple-A part of the deal structure. However, splitting the bottom classes could present a problem, as some of these tranches could suffer a 100% loss severity if the deal experiences a loss.
Analysts also focused on other structural issues such as the reduction of non-recourse carve outs, amortizing bond growth over the last six months, pricing for call protection, the use of WAC floaters, as well as the emergence in non-traditional CMBS asset classes such as condo loans, construction loans (expected to be securitized in the near future) and operating business loans. There was a general consensus among panelists that this is not the end of the story, market participants are going to continue providing a wide array of structuring options and offering tailored bonds.
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