The CMBS industry is taking a moment to celebrate a major milestone. Annual U.S. issuance in 2021 broke the $100 billion mark for the first time since the pre-Great Financial Crisis boom years.
The $110.6 billion of issuance in 2021 is well short of the record high of $227.6 billion recorded in 2007, but the volume doubled 2020's number was 14.5 percent greater than 2019's levels, according to Commercial Mortgage Alert. The increase was driven largely by both the high level of property transactions and refinancing activity from borrowers taking advantage of low interest rates. “Many borrowers have been looking to lock in those rates before the Fed kicks off what could be a substantial number of Fed Funds rate hikes during 2022,” says Lisa Pendergast, executive director of the CRE Finance Council (CREFC).
Strong property values and cheap capital also contributed to record high sales activity last year with transaction volume that jumped to $808.7 billion, according to Real Capital Analytics. “The fact that you had so much transaction volume trickles down with people that are buying property who often want to finance, which was a big driver of what we saw last year,” says Manus Clancy, senior managing director and the leader of the Applied Data, Research, and Pricing departments at Trepp.
Despite the likelihood of higher interest rates ahead, lenders are anticipating another strong year in 2022. According to the Mortgage Bankers Association's (MBA) 2022 Commercial Real Estate Finance Outlook Survey, lenders expect originations across capital sources to increase by an average of 5 percent or more. Clancy predicts that CMBS issuance, including conduit, single asset single borrower (SASB) and CRE-CLO, could rise even higher by 10 to 15 percent.
Conduit volume lags
A closer look at the 2021 data shows that issuance is somewhat lopsided with SASB deals dominating issuance at about $80 billion compared to $30 billion in conduit financing. Meanwhile, CRE-CLO lending, which is tracked separately from CMBS issuance, also posted a new record high number in 2021 with $45.4 billion in financing—double the $19.2 billion in issuance in 2019, according to Commercial Mortgage Alert.
The vast majority of loans backing SASB transactions are shorter term, floating-rate debt that provide borrowers significant optionality relative to a 10-year or even 5-year fixed-rate loan, notes Pendergast. “If a borrower believes the asset has significant potential for income growth, why lock in a 10-year fixed rate loan today? I see SASB volume continuing to be robust in 2022 for this reason,” she says. In addition, CMBS investors are likely to shy away from longer duration assets if they have that choice given the outlook for higher rates going forward with the Fed in play, she adds.
The CRE-CLO market is interesting as it best serves loans secured by transitional assets. To the extent the volume of transitional assets diminish, CRE CLO volume is likely to decline. Like SASB, CRE-CLO loans provide borrowers with significant optionality, says Pendergast. It’s also important to keep in mind the bond investor side of the equation in both the SASB and CRE-CLO markets. “If the view of institutional investors is that rates are on the rise, floating-rate will be their first choice as they shy away from longer duration securities that will be negatively impacted by rising rates,” she says.
One reason conduit growth has been relatively flat is that borrowers have been gravitating towards loans that have more flexibility. Typically, CMBS is not a good fit for borrowers that have a short-term hold strategy and are flipping in and out of properties. However, CMBS does offer an incredibly good value proposition for long-term owners. The concept of locking in a historically low rate on a 10-year loan, particularly in what could be a rising rate environment, is very appealing to a lot of borrowers, notes Rich Highfield, head of CMBS lending at Greystone.
It is difficult to predict whether or not that SASB’s dominance will continue, but Highfield does expect conduit issuance to tick slightly higher. “There was anemic conduit volume in 2011 and 2012. So, part of what you’re seeing in the numbers is the wake of lack of maturities coming through in those prior years,” he says. There will be a slight increase in maturities on 10-year loans made between 2012 and 2016.
Chilly reception for hotels
Another positive for CMBS is that delinquencies are improving. Delinquencies that peaked at 10.3 percent in June 2020 fell to 4.18 percent at the end of January. The hardest hit sectors, lodging and retail, both have notched significant improvement with 30-day delinquencies now at 8.37 percent and 7.96 percent respectively, according to Trepp. There could be some bumps in the road for office, but generally delinquencies are expected to continue to improve, notes Clancy.
Another positive sign for the CMBS market is that the concentration of retail loans has rebounded nicely. Highfield recently conducted an analysis of loan concentrations in conduits. From 2014 up to the start of the pandemic in early 2020, retail loans averaged about 24 percent of conduit loan pools and hotels averaged about 14 percent. Retail and hotel loans within conduits dropped off sharply following the outbreak of the pandemic. Since March 2020, retail has averaged 15 percent and hotels 5 percent.
However, the more recent conduit deals show that retail loan concentration has rebounded, while hotels are still anemic. According to Highfield, retail loans have been averaging 26 percent of loan pools since June of 2021. “When you dive into the retail loans being done, it’s a higher quality of retail,” he adds. Loans are being made to strong grocery-anchored centers versus unanchored centers and B and C malls. There are some hotel loans that are starting to trickle back into the conduit market. Those hotel loans that are getting done tend to be stronger performing assets where they re-opened quickly or newer hotels in destination locations that are less dependent on group events.
The CMBS conduit market is in the midst of transition that could help boost issuance. “Expectations are that investors will see more well-performing retail and hotel in these transactions. What’s more, look for shorter term 5- and 7-year loans as demand will wane from most investors, but not all, for longer duration bonds,” says Pendergast. “We do anticipate more conduit issuance in 2022, and it will be interesting to watch just how much collateral mix, loan terms and bond terms change in 2022 fixed-rate conduit CMBS,” she adds.