Soaring CMBS issuance feeds off market momentum

The demand for higher rates on new commercial mortgage-backed securities deals has soared, leading investors to spend more on insuring against losses on commercial properties.

While CMBS issuance has jumped to its best level since the housing crisis, an industry index launched in January also coincided with a rise in the interest rates that investors demanded on new CMBS, said Stephen Foley of the Financial Times.

“Some analysts attribute that rise to an unexpectedly sharp tumble in the value of the new index, and worry that its persistent weakness could pose a challenge to a range of new CMBS deals that are being marketed this month. The cost of using the index as insurance against CMBS losses rises as its value declines,” he said.

Nonetheless, CMBS issuance is on the rise, reaching $21.3 billion in the first quarter of this year, the biggest total since 2007. At its current pace, issuance may hit $85 billion in 2013, according to Royal Bank of Scotland Securities (RBS)

Meanwhile, the stabilization trend continues for commercial bonds as new CMBS defaults fell to the lowest level since 2008, when 364 loans defaulted, totaling $3.2 billion. 

CMBS defaults fell for the third year in a row in 2012, down 46% from 2011 and 67% from the 2010 peak, according to Fitch Ratings in its latest annual loan default study. 

“Commercial real estate loan defaults are on pace to decline again in 2013, albeit at a more modest pace,” said Britt Johnson, senior director at Fitch. 

She said, “With new issuance gradually increasing and default levels likely to remain stable, cumulative CMBS defaults are not likely to exceed 14% by the end of the year.” 

Additionally, 2007 deals remain the most problematic. Of the new defaults in 2012, 58% came from the 2007 vintage, a stark contrast to older vintages such as the 18% new default rate in 2006 and the 12% rate in 2005.

By property type, office loans continued to lead defaults with $3.3 billion, or 45%, of the total last year, followed by retail with $2.4 billion, or 32.5%, and multifamily with $528 million, or 7.2%, Fitch noted.

“Helping to keep new CMBS default rates stable is the fact that servicers are still modifying loans before a monetary default. If modified loans that were never categorized as in default are included, the 2012 cumulative default rate would be 15.8% instead of 13.4%,” Johnson concluded.

The retail sector continues to be a mixed bag for investors.

However, Harris Trifon and Dave Zhou, research analysts of Deutsche Bank (DB) Markets Research, have maintained a relatively bearish opinion on the property type for quite some time and view the “rampant pessimism in the current market environment as overdone.”

“Although much investor attention should be paid to the structural challenges facing the sector, consumers continue and will always enjoy a well executed retail experience,” they said.

The tremendous increase in large loan CMBS issuance during the first quarter posted more retail loans securitized in stand-alone deals than any previous quarter.

The impressive new pipeline is due to the predominance of high quality assets found in recent deals.

“Demand for ‘credit’ bonds has been particularly strong, which has led to a flatter curve and in turn led the Street to enjoy pricing power over alternative financing providers,” the analysts said.

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