The US commercial mortgage backed securities market is in a bind.
As loans from the pre-crisis boom years come up for refinancing, many borrowers are steering clear of CMBS debt.
It’s no secret that many borrowers found their CMBS sojurn challenging, with the role of the third party debt servicer often cited as a major turnoff, as well as the added complexities of documentation and due diligence.
A simple balance sheet lender on the other hand, such as a large investment bank or an insurance company, can offer relatively simple terms, typically at a better price. Regional banks are also starting to muscle in.
With borrowers shunning the complexities of CMBS in favour of simpler balance sheet lenders, the market is relying on a shrinking pool of properties to deliver deals, concentrating risk in the sector.
Attractive properties such as the GM Building, or select retail properties, are being securitized across several deals. The whole loans on such assets are typically too big for single balance sheet lenders to take on. But with average conduit deal sizes shrinking, there’s a limit on the amount that CMBS lenders can finance in conduit structures, given investors' lack of appetite for deals with more than 10% exposure to a single building.
As a result, the same properties are popping up in multiple conduit deals as well as larger single asset/single borrower deals. The loans cropping up in multiple deals have been the higher quality assets with lower leverage than average, mitigating some of the risk, but fundamentally, spreading the same assets over several deals still leaves investors with a concentration problem.
Added to this is increased sector concentration. Investors are wary of retail exposure, with the proportion of retail assets dropping from 25% last year to 9% in the first half of this year, according to JP Morgan. The share of multifamily exposures is also dropping, as more of these properties find their way into agency-sponsored CMBS deals from Fannie and Freddie.
This is putting added pressure on the office sector to provide collateral for new deals, although the office sector is not without its own credit headwinds.
Regulation isn't helping either. The onset of risk retention rules at the end of last year has seen growing dominance of the market by the biggest bank lenders. The institutions with the capital to cope with risk retention have consolidated their share of the market, and smaller non-banks have been squeezed out.
Securitization is designed to diversify and transfer risk. But the market seems to be doing just the opposite at the moment, as other lending eats into the CMBS market's share of commercial real estate finance. In response, the CMBS market has seen a rise in the use of interest-only loans, described as the 'last tool in the box' to attract borrowers.
The real challenge for CMBS lenders to improve the attractiveness of the product, without sparking a race to the bottom in terms of credit underwriting. Deeper consideration of how to improve the attractiveness of CMBS is required. Efforts by the CRE Finance Council to address the sticking points between borrowers and CMBS servicers throughout the life of the loan are a good start, but the market needs a reboot fast.