CMBS Remain a Viable Choice for Long-Term

DALLAS-Demand for commercial mortgage-backed security is growing in response to upbeat forecasts for commercial real estate and an optimistic outlook by CRE executives. Markets are beginning to recover back to pre-recession levels, and low interest rates combined with rising property values and buyer demand are sending the CRE industry into “go-mode.”

With market observers projecting that new CMBS issuances could reach more than $100 billion in 2013, which is more than double that of 2012, there remains a need to clean-up the overhang from non-performing legacy CMBS before the industry can move forward scotch-free.

According to the latest Fitch Ratings Index Report, more than $14 billion in US CMBS loans will mature in 2013, and “$9.3 billion in loans that already matured in 2013 or previous years are currently delinquent.” In addition, another $20.9 billion in loans that are set to mature beyond 2013 are currently delinquent, including $16.7 billion in 10-year loans from the 2006-2007 vintage.

Although it is true that CMBS defaults have plunged to their lowest levels since 2008, there continues to be notable delinquency on soon-to-mature debt that was underwritten at very low interest rates. Specifically, issuances from the 2007 vintage continue to be responsible for the most troubled loans, and the office sector alone accounts for 45% of defaults followed by retail with 32.5%.

The percentage of defaults in the office and retail industries are expected to decline over the next several years, but as expected in real estate, geography also greatly influences loan “watch lists,” with today's first-to-rebound markets leading the pack with the fewest non-performing loans.

As we continue to see the demand for new CMBS increase along with market recovery, veterans of CMBS workouts must wonder if lessons learned during the past decade of CMBS will sufficiently inform the direction and future of the next generation of CMBS.
I would argue that the following characteristics of the new CMBS marketplace demonstrate that valuable lessons have indeed been learned from our past:

• More conservative terms are better for issuers and borrowers in the long run.

Today, fewer Interest Only loans, lower Loan-to-Value ratios, higher debt service requirements and a more critical review of tenants and tenant leases are helping protect both issuers and borrowers and are helping draw them back to the marketplace.

• More pragmatic timing parameters are advisable.

Markets throughout the country are recovering, and there is more availability of replacement financing. In addition, the impact of global uncertainty less predictable, giving lenders and borrowers a heightened sense of security and reinforcing their decision to consider CMBS financing.

• A more limited number of bond buyers are keeping standards higher, with more stringent underwriting requiring more transparency and proof of concepts.  

Bondholders will continue to be attracted to the yields provided in CMBS until the current economic marketplace provides additional options.

• Today's “bad boy” carve-out provisions in non-recourse CMBS are being enforced and taken more seriously by borrowers.

Legacy CMBS workouts have demonstrated these “carve out provisions” are not only enforceable, but very probable under certain circumstances. Borrowers have seen these consequences via workouts and legal outcomes and now take them more seriously.

These characteristics of new CMBS provide an accurate depiction of where we are today given reasonable underwriting standards. CMBS will remain a viable choice for long-term, non-recourse debt for the foreseeable future, especially given the fear of rising interest rates.

Tanya Little is founder and CEO of Hart Advisors Group in Dallas. The views expressed in this column are the author's own.