According to indications in the CMBS and CMBX markets, and recent reports by all three of the major ratings agencies, there are increasing signs that the commercial real estate debt markets are stabilizing. As we reported in earlier posts, the CMBX and CMBS cash markets were completely divorced from commercial RE fundamentals. Back then, seemingly a hundred years ago, there was no need for a ticket to Vegas: if you were an investor in this sector, all the adrenaline your heart desired could be had sitting right in front of your computer.
Indeed, when nobody was looking and the kids were safely tucked in bed, you could have picked up RAIT Financial Trust (RAS) at $6.75, Northstar Realty Finance (NRF) at $8 and Anthracite Capital (AHR) and $6.50. But as everybody knows, it was no time for the faint of heart, and I lost a lot of donuts employing this price/value thesis on the likes of iStar Financial (SFI) and Newcastle Investment (NCT).
But that was then and this is now. Despite widening in both the CMBS cash market and the CMBX the week before last, the market seems increasingly optimistic that the worst is behind it, and some established players are suggesting that the wild swings in volatility seen since September of 2007 are almost gone for good.
"The yet-to-be-finished de-leveraging process is still likely to exert technical pressure in the market, and volatility could persist for a while as was evident in [CMBX] widening," Citigroup researchers said in their Bond Market Roundup. "But it appears that the market should now be fairly close to fully redirecting attention to the actual and projected performance of the underlying collateral, as this performance, rather than technical forces, should determine bond value going forward."
Recent successful executions of new issue bonds by Lehman Brothers/UBS and JPMorgan/CIBC are also pointed to as examples that the market is returning to something more similar to its former self.
"People say they are comfortable with the fact that CMBS is not connected to residential subprime," a dealer said. "This hadn't been the case until recently."
Indeed, although delinquencies on residential mortgage loans continue to skyrocket, that’s not occurring among U.S. CMBS. Securities backed by commercial real estate loans have deteriorated only modestly. The Fitch Ratings’ CMBS delinquency index rose by three basis points, to 0.33%, in March, the second monthly increase in a row, but still low by historical standards.
“At this point, there is not cause for alarm,” Susan Merrick, managing director and CMBS group head, said in an interview. Although the delinquency rate is expected to rise to about 1% over the course of this year, Ms. Merrick said it will still be “just a bit above the historic average.”
Meanwhile, as the CMBS market sorts itself out and mark-to-market accounting fades from the headlines, borrowers are finding capital elsewhere. According to a new report by S&P, borrowers continue to find parties willing to refinance their CMBS loans, despite reduced liquidity for real estate funding and tighter lending standards.
"Debt financing for commercial real estate is available - albeit at a higher cost - from balance sheet lenders and other market participants, who see a window of opportunity for achieving attractive pricing even on conservatively underwritten loans," the report read.
The report noted that two of the three floating-rate loans with final maturities in the first quarter were refinanced and fully paid off. The third, the highly publicized and much-worrisome Macklowe/EOP loan included in the COMM 2007 FL14 transaction did not pay off at its schedule final maturity. However, S&P suggested that the full retirement of the Macklowe COMM 2007-FL14 debt did take place on April 14. S&P said it viewed the Macklowe deal as highly positive given the transaction's size, complex debt structure and the number of parties with varying economic interests.
Fitch also noted an uptick in loans underlying the CMBS that are not refinancing precisely at their maturity date, thus putting them in non-performing status. The number of loans in this category increased to 11.6% of the Fitch delinquency index in March, compared with 2.9% a year ago.
However, Fitch noted that the majority of the fixed-rate "non-performing" matured loans have paid off in full or extended their terms within 60 days of being transferred to delinquent status, avoiding full default. For example, of the 26 fixed-rate, non-performing matured loans still outstanding at the end of January, only eight loans, comprising $26.2 million, had not refinanced by the end of March.
“Certainly there’s a lot less capital in the markets, but the loans that have matured so far have refinanced” when necessary, with capital being provided either by regional banks or insurance companies, Ms. Merrick said.
As for the CMBS calendar, only two new deals are thought to be in the works, one from Merrill Lynch which may come in the next couple of weeks, and one from Banc of America which may come sometime in May or June, according to Citigroup research.
In addition to S&P, Moody's Investors Service has also been hard at work. In their just released review of US CMBS for the first quarter of 2008, Moody's says the final tally for traditional conduit issuance for the year could be less than $35 billion, but like S&P and Fitch, they expect balance-sheet-driven transactions by financial institutions to take up some of the slack. It is a vast change from last year's record US CMBS issuance of $230 billion.
Nick Levidy, Moody's Managing Director, expects the sector to take "several years to re-group". In retrospect, "perhaps US CMBS should be viewed as a $50 billion to $100 billion per year business that spiked to $200 billion during a credit bubble rather than a $200 billion business having an off year," Levidy adds.
This is probably true, given the multiplier effect that the now defunct SIVs, CDOs and commercial paper conduits had on demand in the CMBS market, and it is yet another reminder to stick with the seasoned veterans.
Disclosure: Long AHR, NRF, RAS
