Entering the Age of CMBS 2.0 with Optimism
Borrowers should not be fearful of CMBS 2.0, the post-bubble generation of CMBS that has both smaller pools and larger loan sizes.
- Jul 20, 2011
By Jeff Majewski,
Head of Debt and Finance Platform, Grubb & Ellis Co.
The much-anticipated return of conduit lenders is upon us. They started to inch their way into the market with multi-borrower conduit deals as early as the second quarter of last year. Through the first half of 2011, CMBS issuance totaled $17.1 billion, up from just $2.4 billion in the first half of 2010. Total volume could top $40 billion by year-end, about three times last year’s volume but well below the peak of $230 billion in 2007.
There are a number of differences between CMBS versions 1.0 (pre-bubble) and 2.0 (post-bubble). An obvious difference is the overall size of the transactions. Prior-generation CMBS would aggregate pools in the range of $2-3 billion, comprised of at least 150 loans. In today’s market, pools are much smaller and are being structured with around 50 assets or so to make it easier for due-diligence teams to review and inspect the collateral pool. In addition to drawing from smaller pools, the average loan size has doubled, moving from version 1.0’s $16 million to approximately $33.5 million. Loans under $10 million will find a short list of suitors.
Post-bubble underwriting is more conservative with lower overall LTV (62 percent) and higher DSC (1.59x). Those numbers are based off of actual in-place operations, not pro-forma rents and lease guarantees by the borrower — which was typical in version 1.0. Rents are generally marked-to-market unless the tenant is investment-grade with a lease term that extends beyond the loan term. Based on a report from Amherst Securities Group, the average rating-agency-stressed LTV on 2007 vintage CMBS was 110 percent, compared with 82 percent for 2010 and 89 percent for 2011 — another sign of more conservative underwriting on new deals.
In 2007, it was not unusual to have the majority of the pool structured with either full or partial IO, or interest only. But full IO is not as prevalent in CMBS 2.0, as partial IO seems to be more available. Funded insurance reserves, taxes and tenant improvements or leasing commissions are now the norm, not the exception. As leases expire, rent rolls are scrubbed while adequate reserves are structured and/or funded to cover potential tenant rollover. Finally, lenders are looking for borrowers who have the liquidity and expertise to protect their equity and the asset — so credit and experience for both the borrower and sponsor are heavily reviewed.
Average spreads in 2010 were 300 basis points over the 10-year Treasury yield, resulting in a blended rate just under 6 percent. In 2011, spreads are hovering around 250 points over the index, resulting in coupons in the range of 5.5 to 5.75 percent. In 2007, spreads were 100 points if not lower, but the 10-year Treasury note was hovering around 4.75 percent, which resulted in “all in” coupons around the same level that we are seeing today.
Borrowers should not be fearful of CMBS 2.0. Wall Street has an insatiable appetite for deals that fit the current market for securitization. If a deal fits in the box, there is no shortage of capital — from traditional life company lenders to conduits.