What Comes After the Fall of the CMBS Wall? Structured Finance
CMBS issuance totaling nearly $100 billion in 2015 fell short of analyst predictions at the start of the year, but covered the $80 billion of conduit loans in need of refinancing—the leading edge of the so-called wall of maturities. Analysts have predicted an even bigger year for CMBS issuance in 2016 as the pace of maturities increases and real estate NOI continues to improve. But if current trends hold, a large percentage of the maturing conduit loans in 2016 and 2017 will not be re-financeable as CMBS deals. Fortunately, other solutions exist.
In January, securities researchers projected 2016 issuance of $110 billion to $125 billion, driven by the $200 billion-plus in conduit loans maturing this year and next. With interest rates expected to rise modestly in the coming months, many owners of properties with 2017 maturities will prepay those loans to lock in lower rates–or so the argument goes. But in truth, market forces seem to be against them.
Although CMBS spreads narrowed in March, the longer trend is a significant widening of spreads as investors become more concerned about loosening underwriting standards and issuers grapple with the added risks of market volatility and new regulations. Investors are also concerned that record-level prices paid for commercial properties might suggest a market bubble that could burst, wiping out borrower equity and putting deals underwater again. Add in worries about the potential impact of rising interest rates, and it becomes hard to imagine that spreads are going to get as thin in 2016 as they were throughout most of 2015.
Trepp recently analyzed six months of conduit originations to determine how higher spreads would affect metrics such as debt service coverage ratio (DSCR), loan-to-value ratio (LTV) and debt yield. The analysis found that 85 percent of maturing loans would cover their DSCR thresholds due to improving NOI and interest rates that are 100 to 200 basis points lower than 10 years ago. If interest rates rise 25 basis points this year, 82 percent of maturing loans will still meet the threshold, and 68 percent could even handle a 100 basis point increase. But only 57 percent of loans are re-financeable under the new LTV threshold, and only 52 percent meet their debt yield thresholds. “If debt yields jump 100 basis points, 59 percent of loans will fall below the minimum required debt yield,” Trepp reports.
In all, an estimated $600 billion to $800 billion in mortgage debt will need to be recapitalized as loans mature. What happens when loans can’t be refinanced in the CMBS market? The answer in many cases will involve some form of structured finance transaction. Bridge loans, mezzanine financing and non-bank financial solutions are likely to play a bigger part in the commercial real estate debt market in 2016 than in 2015. A recent report from Real Capital Analytics (RCA) predicts that one-third of all CMBS loans maturing this year will need some form of mezzanine debt or preferred equity in order to refinance. Mortgages most at risk of being underwater include retail and suburban office properties as well as all property types in secondary and tertiary markets, according to RCA.
Over the past year, we’ve seen specialty finance players beef up their mezzanine debt businesses and an increasing number of preferred equity investors taking a position in properties in need of recapitalization. Banks also have an appetite for this business as they look for high-yield fixed-income investments with relatively low downside risk.
For borrowers, these alternatives will be more expensive than conduit loans but generally preferable to defaults. And higher yields to lenders make sense, given the greater risk as we enter what is considered to be the later stages of the credit cycle.