“Change is inevitable. Growth is optional.” John Maxwell
As the country attempts return to normal, one source of commercial real estate financing is not taking much time off this summer. Private-label commercial mortgage-backed securities (CMBS) are having a strong year as the low volume of new conduit transactions is more than offset by a substantial number of single asset single borrower (SASB) and commercial real estate collateralized loan obligations (CRE CLO) transactions. Mortgage Bankers Association’s Mortgage Debt Outstanding Report shows private-label CMBS makes up roughly 14 percent of the overall CRE finance market as of the end of the first quarter of 2021—roughly in line with its market share as of the end of the first quarter of 2019. The size of the entire CRE finance market was $3.46 trillion in the first quarter of 2019 and $3.72 trillion as of the end of the first quarter of 2021.
While flat percentage growth over two years is nothing to write home about, the reshuffle occurring between different types of CMBS securities is notable. As such, a potential growth framework and tailwinds are in motion for a securitization resurgence. SASB and CRE CLO loan growth are substantial along with continued strong agency issuance. So much so that a generally optimistic set of industry researchers have revised their annual predictions upwards at mid-year.
Hot Products Flying Off the Shelf: Floating-Rate Bonds Energized
The CMBS market’s 2021 upside surprise list includes both SASB and CRE CLO issuance volumes. Commercial Mortgage Alert recently noted, “single-borrower deals accounted for 66.8 percent of first-half issuance, and conduit transactions contributed 33.2 percent.” The below chart from Bank of America’s CMBS research desk compares SASB transactions announced by July 2021 to year-end 2020 volume.
Further, CRE CLO volume came to $20.3 billion by June 30, 2021. Wells Fargo and other research desks recently updated their CRE CLO primers given increased interest in these vehicles. In terms of volume, 2021 has already delivered record-setting CRE CLO issuance, having bested the 2019 annual issuance record of $19 billion by July. See below for detailed stats from Bank of America on recent CRE CLO numbers as compared to 2020.
While investors are clamoring for high-yield, short duration floating-rate investments like CRE CLOs, exposure to multifamily is also an attractive part of the equation. Wells Fargo notes in its primer that the property type makes up 50 percent of outstanding CRE CLO collateral. The legacy transactions issued before March 2020 managed through pandemic conditions relatively well. That is a distinction from conduits and the manageable number of assets in the average CRE CLO transaction also places these bond investment alternatives on a simpler footing than conduits.
Similarly, SASB transactions have experienced relatively strong performance and generally have a straightforward set of property financials, markets and rent rolls to underwrite. Over and above their straightforward underwriting process as compared to conduit transactions that may have 50 to 100 loans, the SASB market benefits from an investor flight to quality, as much of collateral includes trophy properties and/or high-quality sponsors.
Can Conduits Stage a Comeback?
Continued growth for today’s hot products is one thing, but can conduits stage a comeback? No one should hold their breath for a return to 2007 for a host of reasons; however, this year’s low numbers could be transitory. As properties and markets stabilize, originating diverse pools of collateral becomes more feasible. More of the investor questions around performance of certainty office, retail and hospitality assets will be answered over time and lead to the potential inclusion of more of these properties as collateral.
When commercial real estate sale transactions and conduit originations pick up, the number of large, securitized loans that are currently being included in SASB issuance, could see some of their exposure included in conduit transactions. Pieces of large loans were regularly included spread across conduit transactions pre-pandemic, often providing investment grade characteristics and low leverage levels for overall pool metrics. Additionally, existing CMBS loans will mature at a faster pace during the next few years. Maturing CMBS loans and maturing bridge loans will provide ample deal flow if conduits are able to offer compelling terms for these refinance opportunities in a crowded field of competition.
Conduits Keep Passing Monthly Distress Tests
The headline rates for both delinquency and special servicing have trended down for about a year now. Questions remain about whether office delinquency may increase with a long lag relative to increases for hospitality and retail problem loans.
There are significant remaining challenges that should not be understated; however, things are looking up as gauged by both new CRE originations activity and the performance trend line for existing CMBS loans. Today’s specially serviced assets will take time to work through and those assets with significantly reduced appraisals and dim prospects will create inevitable losses. That said, the ultimate recoveries for these assets will take place in a favorable capital markets environment.
Credit Where Credit is Due: A View on CMBS Loan Maturities
Since the last downturn over a decade ago, analyzing the amount of CMBS maturities and associated implications has been habit forming. While admittedly a more valuable exercise for the CRE finance market when CMBS made up 50 percent, it remains an interesting data point for CMBS investors, originators, and servicers. Fitch Ratings analyzes it’s rated book here noting, “approximately $7.5 billion of performing, non-defeased loans within the Fitch-rated U.S. CMBS 2.0 conduit and Freddie Mac universe are scheduled to mature through the remainder of 2021. Maturities are manageable over each of the next three quarters, with $1.6 billion for the rest of the second quarter, $3.1 billion in the third quarter and $2.8 billion in the fourth quarter, but then jumps significantly to nearly $20 billion in 2022.”
Assuming a continued economic recovery between now and 2022, these maturing loans may add to the opportunity set for new conduit originations. Although clearly some of this volume includes loans that will either payoff or are sitting in special servicing today and may continue to do so.
Whether because of improving legacy performance metrics or historically fringe product’s impressive growth, there are reasons not to bet against CMBS going forward whether it be conduits, CRE CLOs or SASB transactions. This is perhaps ironic to say for conduits given some successful bets against some of these bonds via CMBX positions in the last year or two; however, market participants would do well to acknowledge the increasing role securitization is playing for large loan, bridge loan and agency lending programs and its various to efficiently finance commercial real estate. “The securitization technology in commercial real estate has proven its resiliency through many shocks and cycles. Its application to various combinations of underlying collateral is only further evidence of the products staying power,” says UBS managing director Chris LaBianca who also serves as Chair of Mortgage Bankers Association’s Commercial/Multifamily Board of Governors.
Andrew Foster serves as an Associate Vice President at Mortgage Bankers Association. He is based in Washington, D.C. and can be reached at [email protected]. The views expressed herein are those of the author and not necessarily the views of Mortgage Bankers Association, its management, its subsidiaries, or its other professionals.