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Category ArchiveKroll Bond Rating Agency

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

Amidst Flourishing CMBS Results, Single-Tenant Properties Could Raise Concerns

Smart investors have long seen diversification as a central tenet of revenue management. But in the niche realm of commercial mortgage-backed securities, that virtue seems to be growing just a bit less universal.

A new report released by Kroll Bond Rating Agency this week notes that over the last five years, an increasing number of loans securitized into CMBS deals are backed by properties that host just a single tenant. In 2012, less than a tenth of CMBS debt was backed by loans on single-tenant properties. But that number has climbed steadily in the years since, rising to over 17 percent for the first nine months of 2017.

That lack of revenue diversity translates to higher risk, because the property’s entire income stream is concentrated in the performance of just a single company. Even so, the authors of the KBRA report aren’t unduly concerned, noting that a significant portion of those single tenants are especially creditworthy renters.

“Seventy percent of single-tenant exposure is in office,” Larry Kay, a senior director at KBRA, told Commercial Observer. “That has been driven by technology companies such as Apple, Amazon and Google. One good thing that we’ve noticed is that even though we have single-tenant exposure, over 50 percent of the single tenants are high-quality, creditworthy tenants.”

image001 Amidst Flourishing CMBS Results, Single Tenant Properties Could Raise Concerns
CMBS exposure to single-tenant deals has risen steadily over the last half decade.

Even so, Keith Kockenmeister, a KBRA managing director, reiterated that single tenancy can put significant pressure on landlords around the end of lease terms. He noted that a significant chunk of the single-tenant properties backing CMBS deals have leases that expire prior to the transactions’ maturity: “about a third, or 31 percent,” he said. “That could be an issue.”

On the whole, he noted, the trend hasn’t deterred investors in the least. In October, according to KBRA, prices on AAA-rated CMBS tranches fell to an average of 85 basis points on a swaps basis, down eight percent from September. Kay said he believes that the securities buyers’ appetite for CMBS paper may also be influenced by the risk retention rules that went into effect.

“Investors may be attracted to CMBS paper as interests now appear to be more aligned between investors and the issuer base as to long-term performance,” Kay said.

Risk retention rules require the banks that package CMBS transactions to keep a portion of the tranches on their balance sheets, incentivizing them to build less risky financial products.

That, in turn, could encourage investors to buy tranches with a smaller risk premium.

“From [investors’] perspective, they’re probably happy,” about the regulatory regime, Kay said.

That sentiment appears to be contributing to a healthy market. Through October, $71.2 billion in private-label CMBS has come to market this year, already topping the full-year total of $69.2 billion for 2016.

“Rates are still relatively low. Real estate fundamentals are strong. All those together have created a good environment for CMBS,” Kockenmeister said, noting that one area of concern for the firm was the performance of suburban office properties.

“In our travels, we’ve seen [concerns] in markets like Chicago, where a move from the suburbs into Chicago could be a function of millennials’ wanting to be in cities,” Kockenmeister said. “That’s a trend that’s not only impacting Chicago but nationwide.”


Source: commercial

$93M CMBS Loan on West Virginia Mall Sent to Special Servicing

The $93 million loan backed by the Charleston Town Center Mall in Charleston, W. Va., has been sent to special servicing, according to an alert yesterday from Fitch Ratings.

The 10-year term loan, which carries a fixed rate of 5.6 percent, had a securitized balance of $100 million, was originated by Morgan Stanley in September 2007 and was transferred to special servicer C-III Asset Management LLC on Tuesday due to imminent maturity default. It comprises nearly a quarter of the $392 million BSCMS 2007-T28 commercial mortgage-backed securities transaction—originally sponsored by the now defunct Bear Stearns.

The loan is secured by the 931,333-square-foot Charleston Town Center Mall—constructed in 1983 and located at 3000 Charleston Town Center Drive in downtown Charleston, W. Va. It features over 130 specialty shops across three levels of the building, according to information from the mall’s website.

In April, Sears—previously one of the mall’s largest non-collateral anchor tenants, occupying 179,199 square feet of space—closed its doors. Subsequently, the loan was marked as a “loan of concern” by Kroll Bond Rating Agency over heightened concerns about the fates of the location’s two remaining non-collateral anchor tenants, Macy’s and J.C. Penney, each occupying 118,864 and 121,517 square feet, respectively, according to information provided by Trepp.

The loan was then put on the servicer watchlist in June, and in July—as the loan neared it’s September 8, 2017 maturation date—the borrower claimed it was “making changes to the partnership, which they expect to complete concurrently with the loan maturity date” and anticipated it would have the wherewithal to be able to pay off the loan on time, watchlist commentary provided by Trepp shows.

Jeff Linton, a spokesman for Forest City Realty Trust, the property’s sponsor, said in an email statement: “As previously announced, Charleston Town Center is in the midst of restructuring their partnership.  Concurrent with those changes, ownership is evaluating the most efficient way to handle financing for the project.” Linton went on to say that the mall will continue to operate as usual. 

This marks the loan’s first trip to special servicing.


Source: commercial

KBRA’s Eric Thompson on The Evolution of CMBS


Source: commercial

What Does the Investment Sales Slump Mean for Lenders?

If the sales market of recent years has felt like a nonstop party, the cranky neighbors downstairs just called the cops. The lights are back on and the volume is down. A lot.

In the first quarter of 2017, U.S. investment sales volume decreased 26 percent year-over-year, according to numbers from brokerage Cushman & Wakefield.

The decline was even more precipitous in the New York metro area, where investment sales fell 42 percent.

The cause? Take your pick: overbuilding concerns, a looming interest rate hike, rents that appear in some markets to have reached the outer limits of sustainability.

“ ‘Cyclical-plus’ is what I would call it,” said David Schechtman, a senior executive managing director at Meridian Capital Group, suggesting that, while specific events have “definitely fueled the fire,” the plummet is largely just part of the real estate market’s eternal ebb and flow.

Robert Knakal, the chairman for New York investment sales at Cushman & Wakefield, agreed. “You typically see big drops in volume when values start to get challenged, because the discretionary sellers, which make up the overwhelming majority of sellers in any market, don’t choose to sell today for less than they could have gotten yesterday,” he said. “It happens in every cycle.”

Be that as it may, for lenders, the drop in sales could prove inconvenient. Roughly speaking, fewer deals means fewer loans means less money made. And that equation suggests banks may begin looking for ways to fill the hole left by the slumping investment sales business.

Where, exactly, might they turn? One obvious answer is refinancing.

“In any year, probably about one-third of bank lending on real estate is on acquisitions and about two-thirds is on refinancing,” Knakal said. “And that refinancing market will remain.”

In fact, given the number of 10-year loans made during the boom years of 2006 and 2007, many of them in CMBS, 2017 is a particular busy year for the refinancing business.

“We’ve had more mortgages come due than any time ever,” said Marc Warren, a principal at Ackman-Ziff. “Those need to get refinanced, and so that keeps people busy.”

Even with talk of rising interest rates, money is still cheap by historical measures, Schechtman noted. And that, he suggested, will also keep the refinancing market strong.

“If you take a snapshot of any 20- to 30- year period, it’s still a staggering time,” he said. “Three-and-a-half, 4 percent, 4.5, even 5 percent will be a good rate historically.”

Knakal said that the declining performance of properties underlying some of these loans could make lenders less eager to refinance, however.

“I think generally there’s downward pressure on rents in all three major food groups—residential, retail and office,” he said. “Lenders have to look at how the building is performing and how it was performing when they made their initial loan, or when someone else made an initial loan, and figure out if they’re willing to give the same, or less proceeds.”

Given the overall timing of conditions, though, he said he expected most properties currently in need of refinancing to be reasonably well positioned to get it.

“If you look at the five-year loans that are expiring now, they were made in 2012 or 2013, and the property probably saw a significant increase in its performance from 2012 to 2015,” Knakal said. “Maybe if you got your financing in, say, 2015, you might not be able to get the same proceeds today, but in that case you probably still have another three years left on your loan. So I don’t think there will necessarily be a refinance problem.”

On the other hand, the 10-year loans coming due today were issued at the peak of a laxly underwritten market, which has prompted some concerns about their prospects for refinancing, but recent months have provided some cause for optimism. According to a report from Trepp, of the $9 billion in commercial mortgage-backed securities debt that matured in April, more than 95 percent was paid off, which, the report notes, marked “the lowest monthly loss total for maturing debt in the past year.”

Another way banks might try to keep deal volume up is by moving into construction loans.

“There’s probably the least amount of debt available today in construction and development,” Knakal said. “There are a few banks that are active, but that’s a void they could fill in.

Although, he added, “that’s also the area with the highest risk. Some banks, regardless of how difficult it is to put out money, they’re just not going to get into that end of the business.”

“It’s bank specific,” Schechtman said, adding, however, that he has seen bank lending for construction loosen somewhat. “If it’s a development play, you’re going to have to roll up your sleeves and find the right lender. But [in the past] if you were to say, ‘I have a development play,’ the answer would very often be ‘there are just no banks for you.’ Today it’s just a question of how hard do you have to look and what rates do you have to accept.”

Construction “transactions are harder than others, but they still get done,” agreed Warren.

According to a March 2017 report from Kroll Bond Rating Agency, construction and development lending was already a hot area for banks even before the recent fall off in investment sales. Construction and development lending by U.S. banks rose 13 percent in 2015 and 14 percent in 2016, even as banks pulled back from lending in areas including residential mortgages, autos, and commercial and industrial.

The report predicts that C&D lending would continue to grow in the first quarter of 2017, “based on the large and growing level of unfunded commitments at year-end 2016.” It adds that, “given considerable pricing pressures in most loan categories, it is always tempting for bankers to increase C&D lending—a comparatively higher margin, but higher risk loan product.”

Banks’ construction exposure is still relatively low, with these loans representing 3.4 percent of their total origination at the end of 2016. That is well below the peak of 8.4 percent that banks hit at the end of 2007. This might suggest that banks still have room to expand in this area, though the High Volatility Commercial Real Estate (HVCRE) regulations that went into place in 2015 as part of the new Basel III rules could act as a countervailing force.

With certain exceptions, the regulations force banks to classify their C&D loans as HVCRE loans, which requires them to keep more capital in reserve than they would have to for a standard loan.

Beyond refinancing and C&D lending, there are various other opportunities for banks to get money out of the door amidst the sales slump, Warren said.

Transactions like partner buyouts and equity recapitalizations don’t appear as sales but can still require financing, he noted. “Sales are down, and everyone’s investment sales business is down for sure, but the [need for] financing has not necessarily dropped off.”

Schechtman said he expected to see banks tweak their products to try to fill the gap left by the fall in sales. 

“For instance, banks who have historically offered a fixed-rate product for an [lengthy] amount of time may now offer a higher interest rate product for a shorter duration of time. More of a bridge or transitional loan,” he said. “That’s an area in which we’ve seen [demand among] a lot of owners and developers actually increase. I think you’ll see conventional banks do that to the extent that they can do it within regulations.”

There’s also an argument to be made that the drop in investment sales isn’t such an issue for lenders, anyway.

Operating as they are in the stricter Dodd-Frank regulatory environment, banks have slowed their output and wouldn’t have been able to handle the sales deal volume of recent years, said Ira Zlotowitz, the president of Eastern Union Funding. The decline is almost fortuitous, he suggested, because it brings volume closer to what banks can actually manage now.

“It’s happened to work out well for the banks,” he said. “Regulators are stricter with the banks with underwriting and so on, and so they couldn’t do the same volume.”

Whatever slack exists in the market now is also being picked up by the agencies, he said. Fannie Mae closed on a record $55.3 billion in multifamily financing in 2016 and did $17.4 billion in new multifamily financing in the first quarter of the year. “This slowdown relieves what could have been untenable pressure to close an oversupply of deals,” Zlotowitz said.

Schechtman agreed, noting that “increased regulation has precluded [banks] from lending at the same pace” as before.

That said, “banks are no different from all other real estate professionals,” he added. “Banks are transaction based. They want higher volume. They want to be gangbusters all the time.”

He noted, though, that it’s helpful to remember that the recent decline is relative to the go-go market of the last several years.

“There are fewer sales signing and closing than there were a year ago, or certainly 24 months ago,” he said. “But there’s an analogy that I use: When you’re traveling at 80 miles an hour for five or six years in a row, and all of the sudden you come into a 50-mile-an- hour zone, you feel like you’ve slowed down precipitously. But the truth is, you’re still moving along at a wonderful clip. That’s kind of where we are. Deals are still happening. If you ask me if I would take today’s volume over other years in my career, absolutely.”


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