Lending Market Battles Imminent Wall of CMBS Debt

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Jordan W. Silver, Investment Analyst

In 2006 and 2007, loose underwriting paired with 10-year terms made CMBS loans the most highly desirable form of real estate financing. With over $200 billion of CMBS loans coming due through 2017, property owners and lenders are faced with a harsh reality given decreased property values for many assets. This reality, along with lending market volatility and new financial regulations that go into effect this December, have stagnated CMBS lending in the near term.

Delinquencies are substantially higher per Fitch Ratings than historical figures. Many of the well-performing loans originally placed before 2007 have already been restructured to form an A note (primary loan) and a B note (“hope” note) or completely refinanced. Of the remaining properties with original financing in place, many are able to cover the outstanding debt service, but the plunge in property values has put their LTV well over 85% (maximum refinance threshold), making refinancing impossible without a capital infusion from ownership. However, many owners are electing to give back the keys rather than infusing the capital lenders are requiring, mostly due to unachievable property values based on current valuation.

The final component of the Dodd-Frank Wall Street Reform will be implemented this December. This component, risk retention, was designed to discourage the reckless lending that was a catalyst to the financial recession in 2008. Risk retention will require the issuer to hold a 5% piece of the securitization on its balance sheet for the first 5 years of term. Additionally, no sponsor can retain more than their pro-rata share of the total obligation and no issuer can retain less than 20% of the risk retention requirement.

With the wall of impending CMBS loans coming due, many large institutions have left the CMBS market altogether. Through mid-July, U.S. issuance of CMBS is down 43.7% compared to the same period last year according to Commercial Mortgage Alert. The lack of issuance combined with increasing delinquency rates should provide a unique opportunity for three distinct groups: note purchasers, bridge lenders and national/regional banks.

  • Expect scrutiny in new CMBS Loans: Given the newly implemented requirements by Dodd-Frank, when financing through the CMBS market expect more pushback than historically.
  • Take advantage of alternative lending solutions: National and regional banks will be eager to place permanent debt on properties that fall just outside of the new CMBS refinance parameters without a capital infusion.
  • Short term solutions exist: Mezzanine lenders will happily lend on a low (50%-70%) LTV for a 1-3 year term on the group of properties that have maintained strong cash flow but are overleveraged in the CMBS market, with the expectation of refinancing with permanent debt upon expiration.