The CMBS rebound.

Author:Leon, Hortense

CMBS issuance continues to grow as investors remain eager for a nice yield-premium alternative. Yet a few regulatory hurdles cloud the outlook--specifically the risk-retention rules.

The U.S. commercial mortgage-backed securities (CMBS) market looks stable in 2014 and the positive momentum, begun in early 2010, is expected to continue, barring any major macroeconomic upsets. [paragraph] U.S. CMBS ended 2013 with $83 billion in new issuance--a more than 60 percent increase over 2012, according to Trepp LLC, New York. [paragraph] "Most people expect $90 billion to $110 billion in new CMBS issuance in 2014," says Joe McBride, senior research analyst at Trepp. [paragraph] "Bond buyers continue to demonstrate strong appetite for CMBS paper--loans on commercial property--which outperformed residential mortgage-backed securities [RMBS] in the downturn," says Los Angeles-based Steven Orchard, senior vice president of structured finance at Houston-based Transwestern.

"I think there is an appeal to hard-asset collateral in a time of uncertainty, as opposed to holding corporate debt," says Orchard. "In any case, CMBS bonds seem to offer a nice yield premium over other fixed-income assets, so life companies and pension funds are continuing to load up," although life companies prefer to originate their own direct loans because they are looking more profitable today, he adds.

Although in recovery mode, the U.S. CMBS market has a number of challenges ahead of it in the new year, not the least of which is the finalizing of risk-retention rules by federal regulators for asset-based securities (ABS), including CMBS, as well as loosening underwriting standards for new issuances.

And even when the U.S. CMBS market rebounds more fully, its volume is not expected to be much more than 50 percent of what it was before the financial crisis.

The CMBS market will probably cap out at $100 billion to $125 billion, says Gerard Sansosti, executive managing director at HFF LLP in Pittsburgh. "That compares to $240 billion in 2007," he says.

The lower volumes derive from the smaller size of the pools compared with before the recession, just $1 billion to $1.5 billion, compared with $3 billion to $5 billion before the financial crisis, says Sansosti.

Fewer CMBS bond buyers

Lenders don't want CMBS pools to get too large, says Sansosti, because they worry that the bond buyer pool is too shallow. There are a lot fewer players now than in 2006 and 2007, he says. While it appears that the $1 billion to $1.5 billion pools are clearing the market today, CMBS lenders worry about the future when there may not be enough bond buyers, says Sansosti.

Entities that were CMBS bond buyers before the financial crisis but are no longer around today include collateral debt obligations (CDOs) and structured investment vehicles (SIVs), to name a few, says Sansosti.

With fewer bond buyers and smaller pools, individual CMBS loans have to stay below $200 million, he says. If pools have only $1 billion to $1.5 billion each, loans of more than $100 million will make up 10 percent of that pool, he says. Some CMBS lenders even break up deals and put them into more than one CMBS transaction because of their size, he adds.

CMBS lenders don't want to hold on to loans too long, according to Sansosti, "because they typically fund their loans through lines of credit and they pay interest on the money they are lending. Most of the time, the line is a short-term facility that needs to be paid off so that funds can be recycled into the next deal," he says.This situation may also contribute to smaller pools.

At a time when there are fewer CMBS bond buyers, there are too many CMBS lenders for the size of today's CMBS market, according to Sansosti. As of December 2013. there were 26 or 27 of these lenders, so even if the market goes to $125 billion in issuance--and it will only do so if there are enough buyers--that is probably not enough business for all of them, he says.

"There are lots of new CMBS lenders that have established themselves in the last year or so and they hope the market will continue to grow, but the growth may not be that strong, says Sansosti.

"Most newer lenders need to create a niche for themselves by...

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