NEW YORK CITY—The diminution of the CMBS market could pose long-term risk for both larger and smaller banks, Trepp LLC recently told the Federal Reserve's Board of Governors. That risk stems from both a reduction of capital available to banks through CMBS and from an increase in exposure to commercial real estate.

With issuance already down year to date, Trepp sees a further drag posed by the the new risk retention rule mandated under Dodd-Frank. After the new rule takes effect on Dec. 24, “Many participants are saying that we'll see market share reductions for CMBS, because CMBS volumes could be cut by as much as 50%,” Thomas Fink, SVP and managing director, told the Fed governors in a presentation now available as an on-demand webinar through Trepp.

Given fewer lenders in the marketplace, borrowers will need to compete for the remaining capital. “The end result, we believe, will be a 25- to 50- basis points decrease in borrowing costs, which in today's low interest rate environment is an increase of 8% to 15% depending on what your current coupon is,” Fink said in the presentation. He also predicted the elimination of securitizations on single-asset trophy properties “because traditionally that has not included a risk retention or a B-piece installment to it.”

For the banking industry, a decline in the CMBS market would mean less fee income. “When you look at who the largest originators are in CMBS, it's dominated by the banks: well-known banking names,” Fink said. Larger banks also dominate the ranks of servicers on CMBS loans, a factor that would also contribute to “a direct decline of the fee income opportunities for some of the biggest banks in the country.”

Should CMBS origination dwindle, in theory that could open up more opportunity for banks. “They get to pick up market share in a loan category they're familiar with and with less competition, theoretically, they can be pickier and get the better credits, particularly in those secondary and tertiary markets,” Fink said. “Hopefully, that could be a safer book of business.”

The downside of this wide-open playing field is that as many banks become the sole source of capital for commercial real estate in their market, they increase their exposure to the sector. “In addition, they are going to have fewer options to refinance construction and transitional properties, so all the banks are going to have a longer duration aspect which increases their interest rate risk,” Fink told the Fed governors. Moreover, they're potentially moving into increased market share “at a time when real estate values are at their peak,” as they were prior to the savings-and-loan crisis of the late 1980s.

A bright spot in the current CMBS picture is the outlook for losses as 10-year securitizations come due from the peak of the market in 2006 and 2007. “Where some folks have said that upwards of 50% of the loans could suffer losses, we now see that less than 20% of the loans will fall into that category,” Fink said.

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Trepp Sees Bank Risk in CMBS Shortfall

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