The move has been felt acutely in secondary and tertiary real estate markets that have relied solely on CMBS for more than 15 years.
With more than US$1trn in CRE loans maturing between 2012 and 2016, owners of office buildings, shopping malls, large grocery stores and apartment complexes in medium-sized and smaller cities across the country are increasingly finding that they are unable to refinance.
Some have had to sell the properties at a loss or take out a new loan at unattractive terms out of desperation. Others may have to pay exorbitant fees to convince lenders to extend the loans for two more years. Yet others may default.
Meanwhile, CRE projects are being put on hold. Real estate investment trusts, or REITs, which are often dependent on CMBS to fund acquisitions, have had to look for alternative financing options.
And lenders that rely on securitization to fund themselves -- so-called "CMBS lenders" -- have to charge higher interest rates to borrowers in order to account for the less-economic terms they are receiving on the more conservatively structured CMBS that started hitting the market over the past year.
As a result, these lenders are becoming less competitive compared with more conventional lenders, such as life insurance companies, which can offer lower interest rates to borrowers. Insurance companies typically keep the loans in portfolio rather than securitize them.
The only problem: life insurance companies typically only lend in primary and gateway cities, such as
What's more, the wild spread widening and extreme volatility on commercial mortgage bonds over the past two months has made it nearly impossible for originators to accurately quote new loans. So as a result, they just have not.
Last week, the Barclays Capital CMBS AAA Super Duper Index widened out to 323bp, the highest level in more than 18 months, meaning that investors are extremely wary of risk in commercial mortgages.
"This is more than just a momentary pause in CMBS issuance and lending," said Jeffrey Lenobel, a partner at Schulte Roth & Zabel LLP, who represents CRE lenders across the country. "This is serious. Buyers need to refinance. They need money now.
"If you can't sell the bonds, you can't originate the loans."
SUMMER PULLBACK
The CMBS market looked comparatively rosy at the beginning of the year.
The post-crisis brand of more conservatively underwritten CMBS, dubbed CMBS 2.0, was on a very positive trajectory.
This spring, the market was claiming that "CMBS is back" as investors scooped up new issues and risk premiums began to narrow. Deal arrangers were becoming slightly more daring with collateral -- putting in more debt-laden properties compared to similar 2010 deals -- since bond investors were eager for exposure to the juicier yields the product offered.
Some optimistic observers even predicted as much as US$50bn in issuance for 2011, compared to roughly US$12bn in 2010. The market peaked at US$230bn in 2007 before the financial crisis caused CMBS to seize up.
In late July, however, a shocking ratings-criteria snag from S&P caused a deal from Goldman Sachs and Citigroup to get pulled from the market, post-pricing, shattering confidence in the sector. Perhaps more significantly, CMBS further fell out of favor in August amid an aversion to risky spread product due to the deepening European debt crisis, S&P's separate downgrade of the
Now, 2011 full-year issuance has been revised to approximately US$30bn. The expected pipeline for the remainder of the year has decreased by half.
BORROWERS ARE STUCK
Recently, CMBS issuers have had to offer a super-safe 30% Triple A credit enhancement and split their deals into public and private offerings in order to get transactions done and attract a larger pool of investors. And although the Triple A portions of recent deals have been a reasonably easy sell, the riskier, privately-rated slices have not fared so well.
"Investors are not only worried about credit risk; they're worried about funding risk," said Julia Tcherkassova, a CMBS analyst at Barclays. "The recent news from
Investors don't typically finance their CMBS purchases with just their own cash; they take out a so-called repurchase agreement, or "repo" loan, from the bank that sells them the security.
Based on the loan-to-value and other factors of the underlying mortgages, banks can sometimes lend as much as 80% of the value in a short-term financing, in exchange for a certain increase in interest rate. In the current volatile environment, however, when the short-term loan matures, borrowers are not sure if they can roll the loan at the same terms as before.
"The repo terms are getting worse," Tcherkassova said. "Moreover, loan originators don't know what their execution levels will be. Volatility has thrown everything under the table."
Meanwhile, CMBS lenders' rates are no longer competitive: they are quoting 6.5% to 6.75% on new 10-year loans, while life insurance companies are quoting 3.5% to 4.5%.
"Borrowers whose only option is CMBS due to either lack of interest from life companies to lend on their projects or their need for higher leverage and longer amortizations are in a bind," said James DuMars, a Phoenix-based managing director at Northmarq Capital, which helps arrange financing for CRE owners.
CMBS lenders may be able to offer higher leverage than life insurance companies - sometimes lending up to 10% more - but that comes at a steep price.
"If an insurance company is lending US$9m on a property, for example, a CMBS lender may be able to lend US$10m; but look at what you're paying for that extra US$1m. It could be another 150bp added to your rate for that extra US$1m," DuMars said. "That's 15% interest on a US$10m loan. But many of the owners have no other choice; it's painful, and expensive."
Moreover, if borrowers have loans maturing and they cannot refinance, their options are either to sell, or to work out an extension with a special servicer. However, the servicer will want a fee for that extension.
One of DuMars' clients, for instance, had to raise an additional US$1m on a US$5m loan in order to receive a maturity extension from the lender. Another client, an owner of an anchor grocery store in
Yet another client, an owner of a US$50m office building, is seeing the writing on the wall, and is beginning to put cash aside for an impending loan maturity.
"He is losing sleep because he realized we don't have a functioning securitization market," DuMars said. "Moreover, with CMBS loans, you now have to add in lender legal fees running at least $25,000, as all the loan documents have been modified 'to restore confidence'. Add in other legal fees, and a CMBS loan can cost a borrower an extra $50,000; maybe an extra $100,000 at the end of the day."
Still, other borrowers have increasingly taken out Libor-based loans, instead of fixed-rate loans, in order to decrease their interest rate. Then they swap out the loan in the derivatives market through interest rate swaps -- called a 'reverse swap' in the industry -- and wind up with an even lower rate, said Schultz Roth's Lenobel, the lenders' attorney.
"CMBS had created a mechanism for secondary and tertiary markets to be financed since 1996," he said. "When life insurance companies wouldn't look at a US$10m loan in
(Adam Tempkin is a senior IFR analyst)
