The Next Generation CMBS Loan

Who would have thought during the depths of the financial crisis that CMBS financing would be returning to the market by early 2010, if at all? But that is indeed happening.

CMBS lenders are currently “courting very aggressively in the 5 percent range [in interest rates] for good deals,” says David Hendrickson, managing director at Jones Lang LaSalle (JLL).

Bill Hughes

Wall Street investment banks and large commercial banks, such as JP Morgan, Goldman Sachs and Citibank, are said to be actively seeking to execute CMBS financing once more. They may be using capital from their balance sheets to originate the loans, with the intention of eventual securitization.

The government’s Term Asset Backed Securities Loan Facility (TALF) which was expanded to apply to CMBS in the spring of last year, is believed by many to have jump-started the CMBS market. The TALF program offers investors government loans to purchase new issue or existing CMBS. The TALF program is scheduled to be retired by June, but investor interest in at least the highest-rated CMBS appear to remain strong, and spreads for existing AAA-rated CMBS continue to tighten.

To place the return of some form of CMBS financing in perspective, CMBS issuance to investors plunged from a market high of $230 billion in 2007 to $12 billion in 2008, according to Commercial Mortgage Alert. CMBS originations virtually stopped in 2008, and CMBS financing was not available until late last year when the first signs of life emerged in the market. In 2009, the level of issuance was $3 billion.

Wes Boatwright

The handful of CMBS issuances that began to be brought to market beginning in the middle of last year were single-borrower issuances. A CMBS issuance backed by assets of the commercial real estate company Developer Diversified Realty Corp. was the first issuance in that period. Those issuances were snapped up quickly by investors, whether or not they were TALF eligible.

On the other hand, multi-borrower issuances—supported by broad-based CMBS originations—have not been made so far. The most recent CMBS launch, by RBS Commercial Funding, is one for $309.7 million backed by only six large loans. These loans were not warehoused, but were issued close to the time of securitization. It is said that it remains to be seen whether this issuance will be typical of issuances down the road.

In the latest development, JP Morgan said it is considering assembling a pool of multi-borrower, multi-asset loans. This would be an $800 million deal, the largest since 2008, says Bill Hughes, senior vice president and managing director of Marcus & Millichap Capital Corp.

“I suspect they are looking at some legacy loans in their portfolio,” adds Hughes. “What is very important is that this might be structured with a B piece. It will be telling to see how investors will react to this B piece.”

Among lenders, Bridger Commercial Funding may have been the first to announce, late last year, that it was resuming the origination of CMBS loans. Its program was believed to be the first multi-borrower CMBS lending program since 2008.

For a variety of reasons, in the new world of CMBS financing, it appears that larger sized, high-quality, properties, major metro locations, and well-capitalized and well-established, borrowers will be the ones to receive favored treatment.

Deals will be scrutinized more closely than they have been in the past, says Wes Boatwright, managing director in the capital markets group of Jones Lang LaSalle. “I know for a fact that sponsors are being examined a lot closer than they have been in the past,” he says.

It is likely that at the CMBS securities level, issuers will retain an interest—“skin in the game”—in the unrated pieces of the security in the next-generation CMBS. Boatwright surmises this may be mandated by law, the industry or investors (who hold a first loss position on the bonds and thus have an interest in the bonds’ performing well). The implication for borrowers is that CMBS loans will be made more carefully, and there would not be a return to 2007 underwriting standards anytime soon.

Sterling Commercial Capital is one mortgage banker that announced recently it is making CMBS securitized loans as a direct lender. “[The transaction] has to be a blue-chip property, with a blue chip borrower,” says Brian Opert, CEO. “It cannot have any hiccups. There can be no issues whatsoever.” The property also has to have an exit strategy as the company’s investors would not be able to obtain a warehouse line without exits on the properties, he says.

Sterling Commercial offers five-year financing at 25-year amortization for loan amounts of $3 million and up. Interest rates are fixed-rate, at 1 to 1.5 percent higher than for Fannie Mae and Freddie Mac, in the high 6 percent, low-7 percent range, says Opert. DSC is 1.20 to 1.25.

Hughes says that the couple of banks and investment banks offering CMBS-type financing prefers $20 million to $50 million loans on high-quality properties in major MSAs, and will provide up to 75 percent financing—still tighter than the 80 percent financing of yore—and five-year terms. The smallest loan would be about $15 million, he indicates. Interest rates on CMBS-type loans are generally about 6 to 6.75 percent on 10-year loans, and as low as 5.5 to 6.25 percent on five-year loans, says JLL’s Hendrickson.

Nevertheless, it can be argued that when compared to other financing sources, CMBS financing may still offer a financing alternative with some flexibility for multi-housing borrowers. Generally, says Hendrickson, “Life companies are looking for perfect properties. CMBS will accept ‘less than perfect,’ but still ‘very good’ properties.” He says CMBS financing will extend to “quality” Class B properties in secondary markets as long as they are in “decent” locations. “If for any reason Fannie and Freddie cannot finance the deal, CMBS is not far behind,” he says.

Currently, CMBS lenders in general may still be struggling to aggregate loans. Hughes observes that for lenders who are not as well capitalized as the large banks, there was still a lack of warehousing facilities to finance loans originated before securitization.

Securitization is still possible, however. Deals that go to market in the future will likely be a collaboration of a number of lenders’ loans, says Hughes. “These pools will cover the cost of the securitization and assemblage so that there is enough bandwidth to go to market.”

And, lenders admit that the challenge in the marketplace lies primarily in finding good quality product to make loans to. “There are lots of groups aggregating loans. They are finding it hard to find properties to finance to aggregate enough loans to do a securitization,” Boatwright says.

There are also suggestions that there is a possibility large multi-borrower issuances may be impeded going forward because of some ramifications from the Chapter 11 filing of a retail giant in spring last year. In the subsequent case, the court allowed otherwise healthy real estate to be dragged into bankruptcy. Being mindful of this, it is argued, investors could be focused in future on really quantifying sponsor quality. Also, issuances may therefore remain single-borrower where it is easier to examine the sponsor, rather than multi-borrower.

Additionally, lenders may also look more carefully at loan covenants in the next generation CMBS that get securitized, some observers speculate. Loan covenants may be similar to those for portfolio lending, with strict enforcement of bankruptcy remoteness and restrictions on the sponsor’s overall leverage, not just that for the collateral property. Whether or not CMBS will be back for good, it is available again in a stricter form for now.