Joe Clements is co-editor of Debt and Equity Journal, from which this article is excerpted.

Chicago—Forecasts for the US debt market are more troublesome than they have been in a decade, and commercial mortgage-backed securities specialist William T. Barry joins other industry experts fretting that even swift action from the Federal Reserve will not be enough to turn industry fortunes over the near term. CMBS buyers have become decidedly hesitant to accept paper hinting of risk, Barry says, and that has curbed production because lenders are loathe to warehouse notes long-term.

"Conditions are much worse than three months ago," the principal at Chicago-based Draper and Kramer tells Debt & Equity Journal. He adds that uncertainty about spread direction is further disrupting the CMBS pipeline.

Many CMBS lenders are retreating from the battleground, not only refusing to write new loans, but also trying to maneuver out of those already penned. Besides greater use of the "material adverse change" clause often incorporated into loan documentation, some lenders are inviting borrowers to buy back their loans at a discount to move them off the books. "We are starting to see an uptick of that," says one debt broker.

Barry seconds the notion, although he adds the practice has been rather limited to date. "I've seen it happening on a loan-by-loan basis, but I don't think it's all that common," he says. Nor does he anticipate the concept will ease the burden of conduit lenders to any significant degree. The process is too cumbersome for handling such a large volume of loans, he offers, and alternative funding might not be economical enough to make it worthwhile.

The life insurance and commercial banking arenas seem to be another option, and observers concur that such sources have enjoyed a substantial rise in business since July. But since CMBS issuance reached $140 billion in 2006, veteran investment banker George Fantini, founder of Fantini & Gorga in Boston, says, "there are no way banks and life insurers can absorb that amount of business."

Fantini notes that underwriting at such institutions can be more exacting, particularly at a time when CMBS standards are being called into question. "Everybody has a new appreciation for risk," Fantini says, further constricting the supply of capital. As a result, he says, "I think some borrowers will be left on the street corner," particularly those with marginal collateral.

Most financing experts interviewed anticipate certain product types will have trouble being underwritten for a CMBS pool, but not everyone is anticipating long-term damage to the stream of credit for CRE. Although he agrees debt will be more expensive, and buyers may have to invest extra equity to make a deal work, Holliday Fenoglio Fowler managing director Michael Kavanau is less gloomy than many counterparts. The past few weeks have been difficult, he agrees, but Kavanau, attributes part of the lapse to the normal summer slow season. "The market is by no means shut down," he says. "There's still plenty of money out there, even in the CMBS market."

Kavanau believes alternative sources of funds are helping fill the void. Freddie Mac loaned $1.5 billion in the Midwest during one recent four-week period, Kavanau says, an amount that took six months to complete in 2006. Some colleagues such as Barry relay stories that many life insurers have already met their lending quota for the year, but Kavanau says he thinks the inherent value of real estate and its recent performance will enable buyers to secure the necessary funds somewhere.

"The fundamentals are as good as they have been for years," Kavanau says of CRE. The strength of the Chicago market, where Kavanau is based, helped HFF recently arrange $265 million in financing for a 1.8 million-sf mixed-use project there, for example. Kavanau says his group is assisting other clients despite the murkier waters.

At least one national investor who has been active in Chicago concurs with Kavanau's outlook. Including a shopping center just acquired in Joliet, IL, Intercontinental Real Estate Corp. of Boston expects to complete 11 CRE deals during the next 30 days, says the firm's acquisitions director, Michael Keyes. "The instability of the debt markets has been challenging, but we've been able to work through it," he says. A property that closed last week in Waltham, MA, saw substantial competition, adds Keyes, whose firm secured the building at 281 Winter St. for $13.5 million. Highly leveraged bidders may now be at a disadvantage, but Keyes says he believes that desired assets will continue to garner attention. "We see it remaining active," he says of the extended investment sales boom.

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Some Find CMBS Options Limited

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