Mature CMBS Market Could Get Better with Time

MBA (2/13/2008 ) Murray, Michael
Tighter lending criteria combined with maturing loans could help define pricing and restore capital into the commercial mortgage-backed securities market, but it could take time.

A bond market report from Citigroup Global Markets Inc., New York, said the fixed-rate institutional commercial real estate lending environment should remain stable, but tightening lending criteria and maturing floating-rate loans would create headline pressure and potentially a negative feedback loop through the technical CMBX trading.

Market participants use cash bonds marked against CMBX as a macro hedge, and fears of widening spreads are causing threats of mark-to-market losses. "To date, we have seen roughly $100 [billion] to $150 billion of writedowns reported," said Alan Todd, head of CMBS research at JP Morgan Securities, New York. "We have seen some capital injection back into the system, but the reality is that it's not the magnitude of the writedowns but really the magnitude of the unexpected writedowns. As we show it, we see that there is roughly a difference of about $330 billion of incremental writedowns that weren't initially anticipated, which results in almost $4 billion in credit tightening."

Without refinancing options, any debt market would face a “maturity wall,” according to Citigroup’s report. “For commercial mortgages the equation is somewhat different, as much of the domestic financing of commercial loans uses longer-term fixed-rate financing and would have been provided by a more even mix of portfolio lenders and securitization programs,” the report said.

“The investors shorting the product really simply look at it as a method to short commercial property exposures, which they expect are going to decrease in value,” according to Citigroup’s report. “In fact, many of the participants shorting CMBX are not shy about saying they have very little knowledge of the underlying collateral, and yet they have made great money as the spreads have moved wider and wider. For these investors, the product really is not a fundamental trade as much as it is a momentum trade. So, many of these investors realize that most of the classes they are trading will not likely lose money, whether it is the highest rated triple-A class or the triple-B classes. We would say these investors understand that and are taking trade exit risk in a market with limited liquidity.”

However, commercial banks, life insurance companies and FHA and Fannie Mae and Freddie Mac for multifamily properties, keep capital available in commercial real estate. “As a result, recent liquidity crisis events will only directly affect short-term mortgages that mature in the near term,” the report added.

Fears of continued writedowns—from possible commercial loan defaults and investors discounting future expected losses—would constrain credit availability and create greater market volatility, according to Todd. "It may take months for this to occur, but we need the fear of the unknown to moderate, and it needs to moderate through fewer surprise writedowns,” he added.

The unknown of whether ratings agencies will downgrade 2006 and 2007 vintage bonds and the significance of potential downgrades adds to investor risk aversion and prevents a return to market normalcy, according to Todd. "It is very difficult to buy a bond that is rated single A and not know what the ultimate target for that rating is or will be," he said.

JP Morgan Securities forecasts $55 billion to $60 billion in CMBS issuance this year, with $10 billion in the first quarter. For the first time, January had no domestic CMBS issuance with a virtually empty pipeline and loan officers surveyed said they expect less loan demand based on tighter underwriting standards.

"Lenders and borrowers, need to find equilibrium as to what makes sense and the only way, or the major way that will occur, is as people come up for refinance and wind up in the position of being a forced borrower," Todd said.