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

Investors and other stakeholders should be clear on what distinguishes it from, well, CMBS 1.0. Actually, the reboot of CMBS bears a pretty strong resemblance to that first generation of commercial mortgage securitizations, in that conduit lenders are cautiously feeling their way along. "We're a lot closer to 1.2 or 1.3 than 2.0 based on the transactions we've seen," commented Stacey Berger, EVP at Midland Loan Services, during a July webinar presented by GlobeSt.com.

Where the distinction becomes most apparent is between CMBS 2.0 and later iterations of that first generation. In other words, don't hold your breath for something on the scale and complexity of the $3-billion CMBS issue that helped finance the acquisition of the Peter Cooper Village/Stuyvesant Town multifamily complex in 2006.

The new issues of CMBS have been marked by what Berger called "a return to the late 1990s": smaller in scope and, more often than not, driven by lower profile assets such as office and retail properties in secondary and tertiary markets-almost a return to what CMBS as a concept was originally meant to be. A case in point is JP Morgan Chase's $716.3-million conduit package backed by 96 properties in a variety of asset classes across 31 states. There's not a CBD skyscraper in the bunch.

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

Among other strengths, the loans in the pool are geographically diverse and tend to be backed by properties with strong tenancies. According to a presale report from Moody's, the pool has a weighted average loan-to-value of 80.4% and a debt-service coverage ratio of 1.56X. Similarly, Fitch says in its presale report that the 78.2% LTV and 1.37X DSCR it assigns to the pool compares favorably to the average 110.7% LVT and 1.05X ratio across Fitch-rated conduit transactions from 2007 and 2008.

At the single-borrower level, George Smith Partners in June arranged a $24.5- million CMBS loan to provide permanent financing for San Jose, CA-based DJM Capital Partners' 137,232- square-foot Ellinwood 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 bridge financing in 2006. The asset was 100% vacant when DJM bought it.

"Now, four years later, the property is fully stabilized with permanent financing on it, which allows the borrower to payoff the bridge loan," Bram explains. Actually, he relates, the company claims credit for originating the term CMBS 2.0 when it was trying to describe "the return of CMBS lending after the financial meltdown of 2008- 2009."

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

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

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

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

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

Paving the way for these deals were the year's first two multi borrower transactions, which were in fact the first since 2008: the JP Morgan package and its predecessor, a $309.7-million issue from the Royal Bank of Scotland. In a second quarter review of the CMBS market, analyst Sagar Parikh, VP of US fixed income at the Los Angeles-based TCW Group, noted that the RBS deal was "very well received by the investor market" despite its pioneering status in a sector 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 be oversubscribed," Parikh wrote.

Even more significant, argues GSP analyst Nick Silbergeld, was the JPMorgan transaction. "While the RBS deal was important, it was more reminiscent of the single-borrower deals done in the fall than a 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, "clarifies some previous uncertainties in the CMBS market and has other important implications."

The JP Morgan issue succeeded despite the European debt crisis and what Parikh called pricing challenges brought on by the pool's higher leverage and lower credit enhancement. Silbergeld wrote that one of the points proven by the JPMorgan deal was that the CMBS market "has gotten past" the Chapter 11 filing of General Growth Properties.

"One fear from the CMBS meltdown and the resulting GGP bankruptcy was that CMBS investors would no longer view loans backing CMBS bonds purely as a cash flow-producing asset," he wrote. "With a pool backed by 36 loans executing in the market, it means bond investors have put aside their anxiety over the inability to underwrite the borrowers." Based in part on its own experience with arranging the DJM loan, its first CMBS 2.0 transaction, GSP has learned that lenders are now "quick to mark down rents, assume higher vacancy rates and structure holdbacks for properties with significant rollover during the potential new loan term," wrote Silbergeld. "CMBS 2.0 loans need to be backed by properties that have readjusted to new market levels and are at a much lower rent and value basis rather than having a rent roll that is reminiscent of 2007. If CMBS buyers view these new, re-adjusted, rent and vacancy levels as acceptable for the loans backing their CMBS bonds, then they must have a positive view on real estate and economic fundamentals."

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

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

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

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

the GlobeSt.com webinar on distressed assets, John D'Amico, president-elect of the CRE Finance Council, pointed out that senior investors want improved transparency in areas such as reporting packages before they'll pony up for new CMBS. "The emphasis will be on disclosure," said D'Amico. However, Kent says it's encouraging to see lenders, borrowers and originators all seeking ways to make the 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 year ago. It tells you that people are not sitting idle anymore, they're looking for the next wave of CMBS."

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