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Outlook Remains Positive as CMBS Market Entering Late Stages of Credit Cycle

Investors, Ratings Analysts Keep Watch for Warning Signs in CMBS Market
January 6, 2016
Despite the volatility affecting much of the stock market this week, the outlook for U.S. CMBS financing remains positive overall entering into the next year, although analysts and bond rating agencies are keeping an eye out for any signs of trouble as the CMBS market enters the late stages of the credit cycle.

"The collateral quality is still excellent, performance metrics solid and structural protections robust,” said Fitch Ratings managing director Kevin Duignan in his 2016 outlook report. "That said, it's probably safe to assume that structured finance has seen its best days, with underwriting likely to loosen further in some sectors.”

As many noted throughout 2015, the overall credit metrics of commercial mortgage-backed securities started to soften with some raising concerns that underwriting for some CMBS issuances were beginning to reflect the aggressive terms seen in some commercial mortgages from mid-2006 to early 2007.

The loan-to-value leverage in CMBS deals already tops pre-crisis peak levels. Still debt service coverage has remained historically high owing to currently low interest rates, providing good term default risk protection. However, the expected rise in interest rates in 2016 and beyond is expected to reduce this cushion, according to Moody's 2016 US CMBS Outlook.

"With commercial property prices exceeding pre-crisis peaks on an inflation-adjusted basis and most mortgage debt still sized as a percentage of current market value, we are entering the late stages of the current credit cycle," said Moody's director of commercial real estate research, Tad Philipp.

2015 in Review


Full-year 2015 CMBS issuance topped out at $92.1 billion, according to analysts with Morgan Stanley Research, slightly under predictions of $100 billion for 2015, but still 7% higher than 2014 issuance and 17% higher than 2013 issuance.

Publicly offered CMBS deals led the way with 59 deals totaling $61.5 billion. Privately offered single-borrower, single-asset backed deal issuance totaled 52 deals totaling $30.7 billion.

Not counted in those totals were multifamily-backed securities issuances from Freddie Mac and Fannie Mae.

Freddie Mac K deals total 2015 issuance was 27 deals totaling $34.2 billion. This was 58% higher than 2014 and 22% higher than 2013.

In addition, Freddie Mac issued $1.8 billion in small balance deals. $39.9 billion of Fannie Mae DUS pools were issued in 2015, 38% higher than 2014 and 56% higher than 2013.

2016 Outlook


Kroll Bond Rating Agency has the strongest outlook for CMBS issuance in 2016. It expects issuance to reach $125 billion in 2016 aided by the large volume of loans scheduled to mature during the year, coupled with borrowers seeking to lock-in new financing in anticipation of a rising interest rate environment.

Along with the high demand for refinancing loans in 2016, Kroll also said it expects to see continued deterioration in origination standards.

Steven Romasko, head of CMBS research for Nomura Securities International, expects a similarly high issuance level in 2016. However, as a result of delinquency resolutions, increased prepayments, and continued decline in market share for conduit lenders is likely to keep supply marginally net negative.

"Despite our call for an increase in issuance of 25% in 2016, this volume is insufficient to outpace the balance decline resulting from maturities, prepayments, and loan resolutions, resulting in negative net supply of approximately $10 billion,” Romasko said.

Chris van Heerden, director and head of CMBS and Real Estate Research at Wells Fargo Securities, said he expects non-agency CMBS issuance to reach $110 billion, representing a slowing growth rate from 2015. CMBS issuance would grow 5% in 2016 after expanding around 15% in 2015.


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