Commercial-Property Bond Sales Rise, Loan Standards FallSarah Mulholland
Wall Street firms that package commercial mortgages into bonds are recovering from a first-half issuance swoon as they recoup business lost to insurers and commercial banks amid concern that lending standards are being lowered.
About $45.4 billion of securities backed by loans on properties ranging from shopping malls to apartment complexes have been sold since July 1, up from $37.4 billion during the first six months of 2014, according to data compiled by Bloomberg.
A growing number of firms are underwriting debt to bundle into commercial-mortgage backed securities at the same time as insurance companies and banks are vying to finance U.S. real estate. CMBS lenders, squeezed out by the better terms offered by the competition in early 2014, lowered rates and loosened guidelines during the past six months, according to Lisa Pendergast, an analyst at Jefferies Group Inc. in Stamford, Connecticut.
“It was famine and then feast,” in the CMBS market, Pendergast said. Declining interest rates helped boost loan volume, she said, adding that “heightened competition certainly didn’t help CMBS credit quality.”
Sales of CMBS are expanding after doubling to $80 billion last year. Investor demand for riskier assets amid six years of near-zero interest rates is helping fuel a revival of the $550 billion market in which issuance shut down because of the financial crisis.
The underwriting was weaker in CMBS deals offered in the fourth quarter relative to transactions completed earlier in the year, according to JPMorgan Chase & Co. analysts led by Ed Reardon.
One sign of loosened standards is the prevalence of interest-only mortgages, which delay principal payments for several years or until the debt comes due. That means the borrower builds less equity in a property, making it harder to refinance. The percentage of loans that are interest-only for at least part of the term climbed to 71.7 percent in the fourth quarter, compared with 58.7 percent in the preceding months, according to JPMorgan. That’s up from 50.5 percent in 2013.
As sales climb, the quality of loans backing new deals are sliding toward the lax norms of 2007 when a record $232 billion of CMBS was sold, according to Moody’s Investors Service analysts led by Tad Philipp. The New York-based rating company said in a report this month that the decline in standards will persist in 2015.
The U.S. Office of the Comptroller of the Currency said in a report this week that commercial real estate was cited as a particular area of concern among the largest banks in an annual survey of lending standards.
Top-ranked commercial-mortgage bonds have returned 4.36 percent this year while investment-grade company bonds are up 6.95 percent, Bank of America Merrill Lynch index data show.
Wall Street analysts who cut CMBS issuance forecasts in the middle of the year reversed course in recent months. JPMorgan analysts boosted their forecast to $90 billion in September after paring it in May to $80 billion from $86 billion. Jefferies’ Pendergast, who was projecting as much as $110 billion in January, puts the final tally at $90 billion in sales after reducing her forecast to $85 billion during the second quarter.
The rush of deals is expected to spill into next year, with Credit Suisse Group AG forecasting as much $140 billion in 2015. Issuance is poised to rise as debt from the boom years starts coming due and landlords look to refinance early to lock in low rates, according to Credit Suisse analysts led by Roger Lehman.
Interest rates on commercial mortgages packaged into bonds dipped as low as 4.41 percent in November after starting the year at 4.65 percent, according to Morgan Stanley. Borrowers are currently paying an average of 4.45 percent.
The surge in borrowers looking for new loans may be a positive for CMBS underwriting trends, according to Philip Weingord, chief executive officer of Seer Capital Management. The $2.1 billion hedge fund is one of the most active buyers of the riskiest portions of CMBS deals. These investors police underwriting standards by reviewing the loans and throwing out those deemed too risky. Weingord said he doesn’t expect underwriting to slip further in 2015 and that standards may instead be tightened.
“Favorable supply and demand dynamics should put underwriters in a position of strength,” Weingord said by telephone. “The number of loans requiring refinancing in 2015 is significantly greater than 2014.”
Even as the Federal Reserve prepares to raise its benchmark lending rate, the cost to borrow will stay relatively low for U.S. property owners, according to Ed Shugrue, chief executive officer of New York-based Talmage LLC, which oversees $1.5 billion of commercial real estate debt.
The conditions “spell a bonanza for CMBS issuance,” said Shugrue, who said he anticipates $150 billion of deals in 2015.