CMBS Market Boosted By Positive Fundamentals as 2014 Comes to Close

The commercial mortgage backed securities (CMBS) market is expected to end 2014 on solid footing, with loan delinquency rates falling and new issuance likely to surpass last year’s level, according to market observers.

The CMBS delinquency rate fell to 5.8 percent in November, its lowest level in five years, Trepp, LLC reported. As of Dec. 1, delinquencies have fallen 163 basis points, down from 7.4 percent in December 2013, according to Trepp.

“The CMBS market is heading into year-end with a lot of momentum,” said Manus Clancy, Trepp senior managing director. Increased volume, falling delinquency levels, a drop in the Treasury 10-year note yield and lower energy costs have produced a scenario in which “the wind is fully at the market’s back,” he said.

Trepp research associate Joe McBride said new CMBS issuance in 2014 should be just shy of $100 billion, in line with initial estimates for the year. CMBS issuance totaled approximately $86 billion in 2013. McBride noted that a number of factors have weighed on the CMBS market this year, including the interest rate concerns, lending standards, and the upcoming maturation of CMBS loans issued between 2005 and 2007.

While those concerns will likely persist, McBride said, early estimates point to 2015 CMBS issuance volume matching 2014 levels.

CMBS Lenders in Competitive Position for 2015

“CMBS lenders are certainly in a good competitive position for 2015,” said Sam Chandan, chief economist of Chandan Economics and a professor of real estate development at the University of Pennsylvania’s Wharton School. “I think that will allow them to capture a larger share of the market than they did in 2014.”

Ben Thypin, director of market analysis at Real Capital Analytics, said that while new CMBS issuance of about $100 billion in 2014 is still a far cry from the $230 billion raised in 2007 prior to the financial crisis, he noted that “we’re heading in the right direction.”

As for the large number of maturing CMBS loans that come due in 2015, 2016 and 2017, “the capital is certainly out there to refinance these loans,” Thypin said.

“We’re already starting to see new CMBS loans refinance old CMBS loans, often through the same relationship. So, so far, so good,” he added.

According to Moody’s outlook for the CMBS market, 2015 will begin the year with an issuance boost, as loan originators end 2014 with strong pipelines. Issuance in the office and retail sectors, which together account for more than half of the collateral backing recent CMBS loans, will take root in 2015, the Moody’s report said. Both sectors, however, will face “headwinds from evolving space-usage patterns,” it added.

Concerns About Credit Quality

While market observers are optimistic in terms of CMBS issuance volume, they also express some concerns about credit quality.

According to Chandan, although many CMBS lenders have increased their activity in a judicious manner, “there are very clear signs of additional risk-taking.”

One of the easiest to quantify, he said, is the increasing prevalence of interest-only loans. On an individual basis, the loan will be underwritten carefully, according to Chandan. However, “in the aggregate, these increases in interest-only loans are correlated with higher rates of default on current originations,” he said.

Thypin observed that he is starting to see more unconventional property types and secondary market properties comprising a higher proportion of CMBS transactions.

“That’s not necessarily a bad thing, but more a sign of the maturity of the market that it’s starting to cover more ground,” he said.

According to the Moody’s analysis, the credit picture at the end of 2014 looks “decidedly mixed.” Credit quality of outstanding CMBS will remain stable in 2015, Moody’s said, but weaker underwriting standards will lower the quality of new loans.

The Moody’s report noted that the average CMBS loan in the fourth quarter of 2014 represented 113 percent of the value of the property that secured it, up from 112 percent the previous quarter. Moody’s warned that loan leverage as measured by the agency’s loan-to-value ratio, which looks at long-term capitalization rates, “is increasing at such a pace that it will exceed its pre-crisis peak of approximately 118 percent well before the tenth anniversary of the peak” of the market in the third quarter of 2017.