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CREFC 2018: How’s CMBS Doing? KBRA’s Eric Thompson Fills Us In

CREFC’s annual conference at the Loews Hotel in Miami kicked off with an overview of how the CMBS market has been faring, courtesy of Eric ThompsonKroll Bond Rating Agency’s senior managing director. All eyes have been on CMBS with the financing source proving its competitiveness in 2017 and going up against bank and life company loans. Proof is in the pudding, and last year’s issuance volume neared $90 million, surpassing most analysts’ expectations.

Single-borrower issuance in particular increased by a whopping 88.7 percent in 2017 year over year to $36.5 billion, while conduit issuance remained flat at $48.5 billion.

KBRA expects single-borrower issuance to remain strong in 2018. “There’s a number of factors that might contribute to that,” Thompson told Commercial Observer between panels. “Some borrowers may be seeking to lock in a better rate than they currently have, do so ahead of rising interest rates and take some value accretion out of a property. It is also anticipated that M&A activity may spur acquisitions that result in capital market financings.”

There is also a couple of dynamics going on in the single-borrower space that make it appealing to market constituents, Thompson said: “One is that while it can be a very competitive market for pricing and execution for issuers that can lead to compressed profit margins, they can pre-place a lot of the debt with investors and have a good idea of where that execution might be. Two, I think there’s a deeper pool of subordinate buyers who are willing to buy further down in the capital stack because they’re comfortable with the credit on a single asset and comfortable in looking at their basis from the perspective of owning it. Unlike in a conduit deal, if things do go bad, you have more transparency into what conditions can effectuate a change in control as there is only one asset.”

KBRA is aware of a dozen or more single-borrower transactions coming down the pipeline as the year begins and expects to see up to three CRE CLOs issued by mid-February.

At 57 percent, 2017 appraisal LTVs were at their lowest since KBRA began rating conduits in 2012, which is both good and bad. “The issue is that when you have that level of leverage CMBS is competing more with insurers and banks. Even if banks pull back because of regulatory concerns, you have more competition than you would even if you had marginally higher leverage.”  

Historically a financing source dedicated to assets in secondary and tertiary markets, one interesting trend uncovered in KBRA’s research last year was CMBS’ increasing exposure to primary markets. “We found that primary markets default less than secondary markets by two to three points. When they do default, they have losses that are five points less than any other market,” Thompson said. “In the most liquid MSAs, the default rate is actually half that of other market tiers. So this is a positive credit element and a bright spot in terms of trends from prior years.”

CMBS loans in the largest, most liquid markets MSAs—New York, Boston, Washington, D.C., Chicago, Los Angeles and San Francisco—reached 33 percent in 2017, up from 28.1 percent in 2016. When combined with exposure to the next 11 largest MSAs, that percentage pierced the 50 percent level for the first time in KBRA’s rating history, reaching 54.3 percent (compared with 45.5 percent in 2016).

In his opening remarks, Thompson cautioned that, while primary market’s diverse economies can certainly withstand downturns, oversupply is always a concern to consider.

In terms of property types, 2017 was the year of the office with CMBS exposure to the asset class increasing to 39 percent. Perhaps unsurprisingly, retail exposure took a hit, dipping to 25.4 percent after averaging above 31 percent in previous years.

And while delinquency levels remain low, they are increasing. KBRA’s conduit portfolio delinquency rate reached 0.44 percent by year-end 2017, up from 0.15 percent at the end of 2016. The increase was somewhat expected given seasoning in transactions, Thompson said. Term defaults historically peaking between years four and six; the bulk of the delinquency (0.32 percent) is from the 2013 and 2014 vintages.

As one of the most buzzed-about topics at the CREFC conference, it looks like CMBS will continue to shine in 2018.


Source: commercial

2018 CMBS: The Rating Agencies’ Predictions

After a stellar 2017, what’s in store for CMBS next year? We asked the industry experts to opine…


erin stafford 2017 06 27 dbrs 3455 2018 CMBS: The Rating Agencies’ Predictions
Erin Stafford. Jeff Wasserman/ For DBRS

Erin Stafford,  Head of North American CMBS at DBRS

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We are expecting volume to be flat compared to 2017. The lion’s share of the increase in U.S. CMBS volume in 2017 came from increased issuance in the single-asset, single-borrower (SASB) market, while the conduit market in 2017, after adopting risk retention, is likely to end up close to flat from the previous year. It is likely that the SASB volume could remain strong as many of those transactions are short-term in nature and may need to be refinanced into the CMBS market as interest rates remain low.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

We are seeing some softening in certain markets. For instance, Houston was on our radar prior to Hurricane Harvey as office vacancies in the energy corridor had increased in addition to lower hotel occupancies and higher concessions at higher-end multifamily properties. There are markets where new supply may cause short-term disruptions; this is particularly noteworthy for hotels. Regional malls are something that we are watching very closely especially since last year retailers were quick to make store closure decisions following disappointing holiday sales, and we expect this again in 2018. We notice that some mall operators are making great strides to upgrade their offerings while others are lagging, seemingly awaiting more store closures. Other areas we are paying close attention to are suburban office projects and student housing properties.


James Manzi, Senior Director at S&P Global Ratings

jmanzi 2018 CMBS: The Rating Agencies’ Predictions
James Manzi. Photo: Standard & Poor’s

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We’re expecting about $85 billion in CMBS issuance next year, which is slightly lower than this year’s total, which we expect to be around $90 billion. Lower CMBS loan maturities are a headwind, while continued activity in the single-borrower space and the potential for more multifamily collateral making its way into conduits are tailwinds.

Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

With offices taking a leading role in conduits in the 2017 vintage (at around 40 percent of collateral) and being second only to lodging in terms of volume securitized in single borrower deals, we’ll be closely watching performance in that sector. It will be interesting to see if companies (office tenants) choose to use smaller footprints over time, similar to the way retailers have reduced theirs.


zanda lynn 1 2018 CMBS: The Rating Agencies’ Predictions
Zanda Lynn. Photo: Stefan Falke/ For Fitch Ratings

Zanda Lynn and Huxley Somerville, Head of U.S. CMBS Business Development and Head of U.S. CMBS at Fitch Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

Zanda Lynn: Our projection for non-agency CMBS is approximately $75 billion for 2018. We expect the slowdown in commercial real estate activity to contribute to a decline in overall volume, though the single-borrower market looks strong.


huxley somerville 3 2018 CMBS: The Rating Agencies’ Predictions
Huxley Somerville. Photo: Stefan Falke/ For Fitch Ratings




Are there any property type or regions that you are paying close attention to as we go into the new year? Why?

Huxley Somerville: Hotels, while continuing to perform, are showing signs of slowing revenue growth especially in New York City where new construction is adding to underperformance. We do not believe current revenue levels are sustainable over the longer term.


larry kay kbra senior director 2018 CMBS: The Rating Agencies’ Predictions
Larry Kay. Photo: KBRA

 Larry Kay and Eric Thompson, Managing Director and Senior Managing Director at KBRA

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

While we are forecasting that CMBS private label issuance will decline from 2017 levels, there is still good support for new issuance as many positive CMBS and CRE underpinnings remain intact. Interest rates are still historically low, CRE provides favorable returns compared to other asset classes, CRE capital flows while slightly down are still strong, and credit performance remains stable. However, a potential market disruptor could be if the market believes that the Federal Reserve’s balance sheet unwinding is taking too much liquidity out of the system; this could trigger a jump in, or more volatile, interest rates. In addition, investors may be more cautious in their CMBS and CRE allocations in 2018 as property values are beginning to feel stretched, and a decline in scheduled maturities may limit refinancing opportunities. As a result, we are forecasting $65 billion of private label issuance in 2018, which could end up being 25 to 30 percent lower than 2017 levels.

eric thompson kbra senior managing director 2018 CMBS: The Rating Agencies’ Predictions
Eric Thompson. Photo: KBRA


Are there any property types or regions that you are paying close attention to as we go into the new year? Why?

In addition to concerns regarding full-price department stores, in 2018, we will be watching their off-price formats very closely. Chains that report sales with off-price department store offerings include Nordstrom Rack, which just reported fiscal 3Q 2017, and Saks Off Fifth with reported fiscal 2Q 2017 numbers. Both experienced declines in same-store sales performance for each respective quarter and through the nine and six months ending October and July 2017. Declining sales in what has been a high-growth segment leads us to believe there could be sales cannibalization and brand dilution taking place.

Historically, the underlying assertion was that department store retailers would not open off-price stores close to their full-line brand if it cannibalized sales. Based on KBRA’s analysis, which used Nordstrom financial disclosures, the distance between Nordstrom Rack and the retailer’s full-line offerings will increase in the future. Of the existing stores, approximately 42 percent of the off-price locations were situated within five miles of the nearest full-line store—the comparable figure for scheduled openings is just 17 percent. Perhaps this has to do with the availability of real estate. However, it could also signal that the retailer is trying to mitigate the potential for cannibalization and brand dilution.

img 1976 edit 2018 CMBS: The Rating Agencies’ Predictions
Lea Overby. Photo: Kaitlyn Flannagan/ For Commercial Observer

Lea Overby, Head of CMBS Research and Analytics, Structured Credit Research and Ratings at Morningstar Credit Ratings

What are your predictions in terms of 2018 CMBS issuance volume and what will be the key drivers of that issuance?

We expect 2018 nonagency issuance of $70 billion to $75 billion, down slightly from this year’s full-year total of around $85 billion. We are also likely to see another $100 billion in agency issuance next year. The volume of maturing loans that must be refinanced in 2018 will be far lower than in 2017, and most maturing loans are with portfolio lenders, rather than in CMBS. In fact, only $24 billion in CMBS will mature next year, down from over $80 billion that matured in 2017.

Despite the dip in maturing loan volume, we believe that lending may remain relatively constant. We expect transaction volume to remain steady, and borrowers may prepay loans to get ahead of potential interest rate increases. Also boosting CMBS issuance, conduit lenders may become more competitive with balance sheet lenders because conditions in the capital markets remain favorable with tighter CMBS spreads and low volatility. 

Are there any property types or regions that you are paying close attention to as we go into the New Year? Why?

Even though we believe that talk of the retail apocalypse is overblown, we do have concerns for this sector. We expect to see another round of bankruptcies and store closures after the holiday shopping season, and this will likely result in higher vacancy rates in 2018. We will also be keeping a close eye on grocery-anchored space. We believe this sector will see further consolidation, as Amazon’s purchase of Whole Foods and the U.S. expansion of discounters, such as Aldi and Lidl, affect traditional grocers.  Aside from the retail sector, we are also watching the multifamily and hotel sectors. Both have done extremely well during this economic cycle, but the party might not last too much longer. We are seeing signs of overbuilding in certain markets, which may leave multifamily properties and hotels more vulnerable to changes in the economic cycle. There are indications that the stable economy may at last be leading to rising homeownership rates, which may hurt apartment performance. On the other hand, the hotel sector is always vulnerable to economic downturns, and this is exacerbated by increased supply.

Keith Banhazl, Managing Director, Moody’s Investors Service

keith banhazl moodys 2018 CMBS: The Rating Agencies’ Predictions
Keith Banhazl. Photo: Moody’s Investors Service

What does 2018 hold in store for CMBS?

The credit quality of newly originated and outstanding commercial mortgage-backed securities conduit and fusion loans will remain steady in 2018. Rising interest rates and a cyclical inflection point in the commercial real estate cycle pose some challenges to CMBS collateral performance, but declining leverage and increasing coverage in conduit loans provide some degree of protection. Further, the wave of maturing and aggressively underwritten loans from the 2006 and 2007 vintages has mostly come and gone, and we expect the overall delinquency rate to improve as the volume of newly issued CMBS 2.0 loans outweighs that of delinquent CMBS 1.0 loans.

Source: commercial

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Source: commercial

KBRA’s Eric Thompson on The Evolution of CMBS

Source: commercial

Latest Round of Sears Closings Puts More CMBS Loans at Risk

Source: commercial

CMBS Losses in Energy-Dependent Areas Persist, Despite Oil Price Hikes

Oil prices may be on the rise, but CMBS loans in oil-dependent regions are still suffering. In fact, the number of loans at risk of default has actually increased over the past year, according to a report by Kroll Bond Rating Agency shared first with Commercial Observer.


Fifteen months ago KBRA designated 38 CMBS 2.0 loans ($684 million in principal balance) as oil-exposed “loans of concern,” meaning loans that are either in default or at heightened risk of default. That number has since risen to 83 loans, or $1.1 billion in principal balance. Further, 35 of those loans are in special servicing and 28 loans have been assigned appraisal reduction amounts totaling $148 million.


The loans of concern are in energy-related markets including Louisiana, Montana, New Mexico, Oklahoma, Pennsylvania, Utah, Washington and West Virginia. Many are collateralized by lodging properties, which have felt the brunt of reduced demand from oil workers and energy-related industries.


Although oil is now trading around $50 per barrelcompared with $30 per barrel a year agoemployment in the energy sector has not fully recovered. Consequently, fewer jobs have resulted in weaker property fundamentals in oil-dependent regions. “Property cash flows have been unable to support required debt-service payments and collateral values have fallen below origination proceeds, which prompted a number of loans to become delinquent,” analysts wrote.


North Dakota has a particularly high concentration of oil-related employment, and KBRA has upped its weighted average loss severity estimate to 76.7 percent from 63.7 percent for the state. The oil-rig count in North Dakota reached 189 in September 2014 before falling to just 22 in May 2016. The count has since doubled to 44, but that number is still 75 percent below 2014 levels.


Loss estimates for Texas have also increased sixfold, to 14.9 percent from 2.6 percent, primarily driven by the lodging sector.  In Houston, however, an uptick in office vacancies is contributing to the pain, as a wave of new office supply came online while energy companies were busy reducing their space requirements.
With oil production and oil-rig counts increasing, renewed growth in energy-related industries may be around the corner, analysts wrote. However, any recovery is likely “too little, too late,” for more than one third of the oil-related loans of concern that are either 90 days delinquent, in foreclosure or real estate owned, and those loans’ transactions will likely experience losses and downgrades.

Source: commercial