Finance N Illinois

Five things to know about the CMBS markets -- yesterday, today and tomorrow

  

CMBS markets have come a long way since their virtual shutdown during the financial crisis. In the dark days of 2008-2009, many people questioned whether CMBS (Commercial Mortgage-Backed Securities) would survive.

A decade after the height of the market in 2007, many of the worst-case predictions have not come to pass—but there are new clouds that loom over the sectors most engaged in CMBS, particularly the disruption of retail by e-commerce.

For CMBS borrowers and would-be borrowers, context is everything. Here are five things you need to know about CMBS markets yesterday, today and tomorrow.

1. There’s no flood of defaults coming to the market as was once predicted.

Defaults were expected to skyrocket in 2017 as 10-year maturities from 2007 came due, but we dodged the apocalypse, and defaults have been much lower than initially expected. According to the Mortgage Banker’s Association, delinquency rates for commercial and multifamily mortgage loans were flat or decreased in the first quarter of 2017.

Growth in property incomes and property values, coupled with low interest rates, have facilitated financing. As we near the end of the second quarter, the industry has largely worked through the so-called ‘wave of maturities’.

Many properties that suffered from defaults in the years 2009-2013 were either foreclosed and sold, or the notes were sold, and the loans were all paid off years ago.

2. We can thank the debt funds and insurance companies for fewer defaults.

Ultimately (and fortunately), the CMBS markets did not fulfill the dismal predictions from a decade ago; in fact, CMBS defaults stalled and sometimes even decreased in Q1 of 2017.

Life insurance companies have played a role in funding high-quality, low-leverage deals for many long-term property owners. New debt funds and some life companies have increased leverage by providing an alternative capital source for borrowers to turn to. The extra 10 percent to 15 percent of proceeds are made available by mezzanine financing, which has allowed borrowers to take advantage of positive market conditions and defease loans prior to maturity or time the funding at maturity and avoid default.

3. Fannie and Freddie may be involved in the refinancing of CMBS maturities.

Maturing multi-family CMBS loans have opportunities for Fannie Mae and Freddie Mac loans to lever LTV rates. Multi-family CMBS maturing loans that are seeking additional leverage beyond the typical 70 percent to 75 percent loan-to-value (LTV) advance rate can be levered to 80 percent LTV with government-backed Fannie and Freddie loans, with low interest rates.

4. The Amazon Effect is real.

E-commerce is moving past its infancy phase, and its effect on shopping centers funded by CMBS and all mortgage lenders has already been significant. Amazon is the undisputed leader in e-commerce, and its success has caused the entire brick-and-mortar retail industry to slowly shut down.

Every week, new retailers announce massive store closings. JCPenney is closing 140 stores, Macy’s is closing 100 stores, Sears is closing 150 stores and CVS is closing 70 stores. The trend in store closures means there are far too many retail storefronts in America than are actually needed. As malls and shopping centers shut down, neighborhoods also suffer. Since retail is a major sector financed by CMBS, many CMBS issuances will be impacted, in turn.

The disruption of retail brought on by the boom of e-commerce may threaten CMBS-financed retail. However, retail owners are filling anchor store vacancies in increasingly creative manners by bringing in corporate offices, experiential entertainment and hotel rooms to name a few.

5. Regulating and special servicing keep CMBS complex.

Underwriting and special servicing have transformed in the last decade, changing the game for borrowers, lenders and regulators alike. The main difference between CMBS 1.0 and 2.0 are the underwriting standards placed on securitizations by the “B” piece buyers and the risk retention regulations required as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires issuers retain a piece of risk from every transaction they issue.

These two changes have increased the cost of doing CMBS business, the result of which are higher interest rates and lower leverage. The market is adjusting to the new rules, as CMBS issuance for May 2017 was the highest in two years.

Special servicing changes the game for a loan, but it doesn’t necessarily mean a default must occur. Many loans get transferred to special servicing when an “imminent default clause” has been activated. Often, the clause is triggered by payment defaults, maturity default, bankruptcy, foreclosure or changes in LTV ratio or debt-service coverage ratio (DSCR).

The CMBS servicing challenges is the Achilles heel for the industry, and the lenders and servicers are trying to improve this aspect of the business. There are many different layers of investors, approvers and participants with different interests involved in the servicing side of the business, which is what makes improving this such a challenge.

As CMBS continues to evolve, understanding this decade-long journey from the bleak financial setting of 2008-2009 is key in navigating the market today, and there are improvements to relay to borrowers.

Ben Kadish is founder of Chicago’s Maverick Commercial Mortgage.