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Was Dip in January CMBS Issuance Just a Dip? Or Something More?

Decline in CMBS Issuance Concerns CRE Investors, Although Survey Respondents Expect Both Debt and Equity Financing to Remain Available and Stable
February 17, 2016
Recent loan underwriting warnings by banking regulators and a sharp decline in CMBS loan volume in January prompted two Morgan Stanley structured finance analysts to cut their CMBS lending projections for 2016 and adjust their already modest expectations for CRE price appreciation this year.

"Tighter financial conditions are leading us to reduce our CMBS 2.0 private-label issuance projections to $70 billion, and our price appreciation projection for CRE from 5% to 0%, with risk to the downside," Morgan Stanley analysts Richard Hill and Jerry Chen said in a report this week.

Put off by market volatility last month, only four private-label CMBS transactions totaling $2.9 billion priced in January, the lowest sales volume for the start of a year since 2012, leading Morgan Stanley to trim its 2016 CMBS issuance projection 30% from $100 billion.

The start of 2016 has been a bit of bumpy road for CMBS after enjoying a mostly smooth ride in 2014 and 2015. New-issue spreads widened by as much as 30 basis points on AAA-rated bonds and around 240 bps on BBB -- levels last seen in 2011.

Morgan Stanley's Hill said the recent widening in CMBS triple-A spreads constitutes a "catch-up, sell-off" response to the weakness by traders as observed in the investment-grade corporate bond market. CMBS triple-B bond spreads saw an even-more pronounced widening in three new issue CMBX transactions which priced at the end of January, Hill said.

CMBS spreads are likely to continue to widen, chiefly because spreads and yields remain below previous corrections, according to an analysis of past market corrections by Hill and Chen.

Pricing for core commercial property assets has been especially strong, with the value-weighted U.S. Composite Index segment of the CoStar Commercial Repeat Sale Indices (CCRSI) rising 12.6% during 2015 to an all-time high of 19.1% above its pre-recession peak. Potential headwinds to rising commercial real estate prices has shifted from concerns over higher interest rates to tighter financial conditions for two main reasons, Morgan Stanley said.

Last December, the FDIC called on lenders to reinforce prudent CRE lending risk-management practices, expressing concern that many banks’ CRE concentration levels have risen and noted banking agency supervisors will be paying special attention to loan underwriting and potential risks associated with CRE lending, Hill said.

That call created the appropriate response, with this month's Senior Loan Officer Opinion Survey on Bank Lending Practices by the Federal Reserve Bank pointing to tightening financial conditions for real estate, especially multifamily.

Survey respondents indicated that their lending standards for CRE loans of all types tightened during fourth-quarter 2015, while CMBS issuance volumes fell to their lowest levels since 2012.

While Morgan Stanley previously projected an average of 5% in CRE price appreciation in the year ahead, driven mainly by NOI growth since further cap rate compression is limited, "tighter financial conditions are leading us to reduce our forecast for CRE price appreciation in 2016 to zero percent, with risk to the downside," Hill said Chen said.

There is no shortage of mixed signals for market watchers. Even as the volatility in spreads is forcing lenders to take a cautious stance, CMBS loan delinquency rates continue to post declines. Fitch Ratings recently reported that CMBS loan delinquencies recorded their largest month-over-month decline since the rating agency started its index 15 years ago, falling from about 4.% at the end of December to 2.93% at the end of January.

Although the decline was expected because last month's remittance data included the resolution of the massive $3 billion loan on Manhattan's Peter Cooper Village and Stuyvesant Town, the last time delinquencies were below 3% was in June 2009.

The decline in delinquent loans is significant due to lingering investor concerns about the industry’s ability to refinance record levels of maturing CMBS loans. Such worries remain widespread, with 87% of respondents in a new real estate sentiment survey by law firm Seyfarth Shaw expressing significant concern over how the industry will refinance the wave of $111 billion in CMBS loans coming due in 2016.

Meanwhile another market monitor, the First-Quarter 2016 Real Estate Roundtable Sentiment Survey conducted for the Roundtable by FPL Advisory Group, came in at 50, a seven-point decline from the fourth quarter. FPL attributed the decline largely to rising investor concerns over a slowing global economy, particularly in China, and volatility in public financial markets.

In the capital markets, Roundtable respondents reported that debt and equity capital is still generally plentiful and available, with the exception of some turbulence in the CMBS and public REIT markets.

"The CMBS market is in a state of turbulence, but debt capital is still plentiful. The investment grade markets are still very strong," one investor said.

"Things are pretty healthy on the capital side. Capital formation is healthy, institutional allocations are high, cost of capital is low, the price of debt is low, and the cost of equity is attractive. Barring a geopolitical event, I’m seeing a favorable, stable situation," another investor said.

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