Keeping the Faith on CMBS Amid Market Forces

By Nicholas Ziegler
News Editor, Commercial Property Executive

In real estate, everything is connected. The health of the economy in general, as always, affects the rest of the market, sometimes in unexpected ways. In recent months, amid a European debt crisis, deepening concerns over employment numbers and on-the-sidelines speculation, there is growing concern over the CMBS market. As recently as this summer, analysts were calling for an increase in CMBS issuances – but a series of factors has seemed to derail the recovery, of both the economy in general and the CMBS market specifically.

In a report released yesterday by law firm DLA Piper – its fifth “State of the Market Survey” – an overwhelming majority of respondents predicted a cooling of the CMBS market. While 46 percent of the responding CRE executives and senior managers expected transaction volume to hit the $30 billion to $40 billion range, 48 percent predicted that CMBS would only reach the $25 billion to $30 billion range for 2011. And despite potentially more attractive loan terms available from CMBS, 55 percent favor financing from conventional lenders. As one respondent wrote, “Turmoil in the CMBS market has made debt unattractive and thus the pace of acquisitions and refinancings must slow as a result, which should cause cap rates to rise.”

Trepp was even more clear in its early-October report: “There is no denying the CBMS market has been acutely negative in the past three months,” the research firm said. With a huge drop in delinquencies in August, it looked as if things might be turning around. But there have been a lot of changes in the last three months: Spreads have risen sharply, lenders are no longer offering new loans, the economy in general has weakened and some in commercial real estate have speculated that trophy-property pricing has risen too quickly.

But it’s not cause for panic.

According to a report by Cushman & Wakefield, CRE delinquency rates continue to slowly improve, with CMBS delinquency rates 100 to 200 basis points worse than bank delinquencies — which are at roughly 7.0 percent. Fitch Ratings has taken proactive steps to raise enhancement levels for new CMBS to ensure “ample credit risk protection” and has pledged to continue raising those levels “if standards continue to decline further.” And as Commercial Property Executive reported in its September issue, banks such as KeyBank are actively searching out new loans under their CMBS arms.

It appears to be a question of discipline, then, on the part of the lenders. “In football, the old saying goes that you are never as bad as you look when you’re losing, nor are you ever as good as you look when you’re winning,” Trepp wrote in its report. “So was the case with CMBS in September.  While many of the headlines were sharply pessimistic in tone, not all of the data was negative.” Huxley Somerville, group managing director of CMBS for Fitch, stressed the need to keep that winning mentality.

“Fitch agrees that underwriting standards have declined in the last 12 months,” he said. “However, it should be noted that deterioration thus far has been off of very high standards. In other words it was only a matter of time before underwriting standards began to decline from such an unusually high level.”

As Somerville said at the close of his report, “It behooves all in the industry to ensure that discipline and memories are maintained so that the industry, too, is maintained.”