Although the delinquency rate on legacy CMBS continues to tickupward, securitization has risen from the ashes of the 2008-2009capital-markets fire storm. The phoenix is still finding its wings,though, and even the most upbeat predictions don't anticipate thatthe volume of new CMBS this year will reach more than about 14% ofthe $207 billion achieved in 2007. Yet what industry players arecalling CMBS 2.0 is gaining altitude.

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Investors and other stakeholders should be clear on whatdistinguishes it from, well, CMBS 1.0. Actually, the reboot of CMBSbears a pretty strong resemblance to that first generation ofcommercial mortgage securitizations, in that conduit lenders arecautiously feeling their way along. "We're a lot closer to 1.2 or1.3 than 2.0 based on the transactions we've seen," commentedStacey Berger, EVP at Midland Loan Services, during a July webinarpresented by GlobeSt.com.

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Where the distinction becomes most apparent is between CMBS 2.0and later iterations of that first generation. In other words,don't hold your breath for something on the scale and complexity ofthe $3-billion CMBS issue that helped finance the acquisition ofthe Peter Cooper Village/Stuyvesant Town multifamily complex in2006.

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The new issues of CMBS have been marked by what Berger called "areturn to the late 1990s": smaller in scope and, more often thannot, driven by lower profile assets such as office and retailproperties in secondary and tertiary markets-almost a return towhat CMBS as a concept was originally meant to be. A case in pointis JP Morgan Chase's $716.3-million conduit package backed by 96properties in a variety of asset classes across 31 states. There'snot a CBD skyscraper in the bunch.

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Yet at the same time, the JP Morgan package and other recentCMBS deals reflect "a return by loan originators to prudentunderwriting," says Pat Sargent, a partner at Dallas-based AndrewsKurth LLP and past president of the CRE Finance Council. BothMoody's Investors Service and Fitch Ratings assigned AAA ratings to$608.9 million of the loans.

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Among other strengths, the loans in the pool are geographicallydiverse and tend to be backed by properties with strong tenancies.According to a presale report from Moody's, the pool has a weightedaverage loan-to-value of 80.4% and a debt-service coverage ratio of1.56X. Similarly, Fitch says in its presale report that the 78.2%LTV and 1.37X DSCR it assigns to the pool compares favorably to theaverage 110.7% LVT and 1.05X ratio across Fitch-rated conduittransactions from 2007 and 2008.

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At the single-borrower level, George Smith Partners in Junearranged a $24.5- million CMBS loan to provide permanent financingfor San Jose, CA-based DJM Capital Partners' 137,232- square-footEllinwood Office Complex in Pleasant Hill, CA. Steve Bram,principal and managing partner with Century City, CA-based GSP,tells GlobeSt.com that the firm had arranged the acquisition bridgefinancing in 2006. The asset was 100% vacant when DJM boughtit.

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"Now, four years later, the property is fully stabilized withpermanent financing on it, which allows the borrower to payoff thebridge loan," Bram explains. Actually, he relates, the companyclaims credit for originating the term CMBS 2.0 when it was tryingto describe "the return of CMBS lending after the financialmeltdown of 2008- 2009."

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The kind of rigor underpinning these deals, says Mike Kent,

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US president of asset and property management services forColliers International in Los Angeles, is "not a bad thing to have.Stricter underwriting is a benefit to the overall strength of thereal estate industry. We can't have underwriting topple theindustry or the economy." Among the beneficiaries of that caution,he adds, are those who buy pieces of the CMBS pool.

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Since the DJM deal was finalized, single- and multiple-borrowertransactions on a larger scale have been in the works. The DurstOrganization secured $650 million in CMBS loans as part of a$1.3-billion refi on its One Bryant Park office tower in MidtownManhattan the second on the property in as many years. Theremainder came from tax-exempt bonds issued by New York State.

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The Wall Street Journal reported in July that Goldman Sachs andCitigroup are leading

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a $750-million CMBS issue. It will include a $100-million loanby Citigroup to Flagship Partners LLC to refinance debt on theportion of 660 Madison Ave. in Manhattan that houses the BarneysNew York retail department store, according to the WSJ.

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Paving the way for these deals were the year's first two multiborrower transactions, which were in fact the first since 2008: theJP Morgan package and its predecessor, a $309.7-million issue fromthe Royal Bank of Scotland. In a second quarter review of the CMBSmarket, analyst Sagar Parikh, VP of US fixed income at the LosAngeles-based TCW Group, noted that the RBS deal was "very wellreceived by the investor market" despite its pioneering status in asector where the news for months has been rising default rates."The underwriting standards of the CMBS 2.0 era (lower leverage,in-place cash flows, well performing properties) led the deal to beoversubscribed," Parikh wrote.

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Even more significant, argues GSP analyst Nick Silbergeld, wasthe JPMorgan transaction. "While the RBS deal was important, it wasmore reminiscent of the single-borrower deals done in the fall thana true multi borrower CMBS pool," he wrote in a note to clients."There were only six loans averaging over $50 million and totaling$309 million." The far larger JP Morgan pool, he wrote, "clarifiessome previous uncertainties in the CMBS market and has otherimportant implications."

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The JP Morgan issue succeeded despite the European debt crisisand what Parikh called pricing challenges brought on by the pool'shigher leverage and lower credit enhancement. Silbergeld wrote thatone of the points proven by the JPMorgan deal was that the CMBSmarket "has gotten past" the Chapter 11 filing of General GrowthProperties.

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"One fear from the CMBS meltdown and the resulting GGPbankruptcy was that CMBS investors would no longer view loansbacking CMBS bonds purely as a cash flow-producing asset," hewrote. "With a pool backed by 36 loans executing in the market, itmeans bond investors have put aside their anxiety over theinability to underwrite the borrowers." Based in part on its ownexperience with arranging the DJM loan, its first CMBS 2.0transaction, GSP has learned that lenders are now "quick to markdown rents, assume higher vacancy rates and structure holdbacks forproperties with significant rollover during the potential new loanterm," wrote Silbergeld. "CMBS 2.0 loans need to be backed byproperties that have readjusted to new market levels and are at amuch lower rent and value basis rather than having a rent roll thatis reminiscent of 2007. If CMBS buyers view these new, re-adjusted,rent and vacancy levels as acceptable for the loans backing theirCMBS bonds, then they must have a positive view on real estate andeconomic fundamentals."

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There will be more conduit deals as 2010 progresses, Sargentsays, provided that transaction volume picks up. "A big part ofseeing new CMBS issues is going to be more properties trading handsand those that are maturing getting refinanced," he says.

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"We're starting to see that, but because of the valuation drops,you're going to have new equity in a number of cases."

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Kent sees would-be CMBS buyers as playing "a wait-and-see game.People are curious and they're cautious." That caution willcontinue until there's more deal flow, he adds. As to when thatincreased velocity will happen, "If you had talked to me a yearago, I would have said the first quarter of this year, andeverybody else would have agreed."

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Besides the relative newness of CMBS 2.0, investors also remainnervous about the little matter of rising default rates on legacyproduct. Trepp puts the CMBS delinquency rate at 8.59% for June,more than double the 4.07% it reached a year ago. And in

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the GlobeSt.com webinar on distressed assets, John D'Amico,president-elect of the CRE Finance Council, pointed out that seniorinvestors want improved transparency in areas such as reportingpackages before they'll pony up for new CMBS. "The emphasis will beon disclosure," said D'Amico. However, Kent says it's encouragingto see lenders, borrowers and originators all seeking ways to makethe deals happen. "That tells you that creative minds are at work,looking for solutions and how to get back into the game," he says."You didn't see that six months ago, and you didn't see it a yearago. It tells you that people are not sitting idle anymore, they'relooking for the next wave of CMBS."


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Paul Bubny

Paul Bubny is managing editor of Real Estate Forum and GlobeSt.com. He has been reporting on business since 1988 and on commercial real estate since 2007. He is based at ALM Real Estate Media Group's offices in New York City.