Respondent views on CMBS lending are more pessimistic, which is not a big surprise given the sharp drop in issuance this year. At $30.7 billion, issuance for the first half of the year is down 44 percent compared to the same period last year, according to Commercial Mortgage Alert, an industry newsletter. Widening spreads and some loan kick-outs by B-piece buyers as a means to manage risk have slowed the pipeline. Deals are expected to ramp up again in the second half of 2016. “The big question is what’s going to happen at the end of the year, when risk retention kicks in,” says Bob Restrick, CEO at Walker & Dunlop Commercial Property Funding.
The CMBS industry is still trying to figure out how the new risk retention rules will impact the market when they go into effect on December 24th. In August, Wells Fargo, Bank of America Merrill Lynch and Morgan Stanley were the first to test the waters with WFCM 2016-BNK1—the first conduit deal structured to follow the new risk retention rules. Although the deal was well-received by investors, regulators have yet to provide guidance on how they view the structure.
The risk retention rules will require originators to keep some skin in the game by holding a piece of the deal that they helped to put together. In the case of the WFCM 2016-BNK1 conduit, the originators opted to hold a 5 percent “vertical strip” or a $43.53 million carve-out that included a piece from all of the bond classes. “There are enough firms that will take down the vertical strip such that originations will not slow significantly due to risk retention,” says Restrick.
However, a majority of survey respondents do think that the new risk retention rules will have a negative impact on CMBS loan availability over the next six months. Sixty two percent believe that the risk retention rules will have at least some impact—including 18 percent who said the rules will have a significant impact on CMBS loan availability. Thirty-four percent predict no change and 5 percent expect risk retention to increase loan availability. In addition, 61 percent believe that CMBS loan terms will be less favorable over the next six months due to the new risk retention rules, while 31 percent anticipate no change and 8 percent think CMBS loan terms will be more favorable.
Historically, CMBS has been a place where middle-market, higher leverage borrowers have come to access financing. There are going to be some situations where loan availability for properties with higher leverage or in less favorable locations will be impacted, with a potential pullback on overall leverage, says DeRoy. “But I still believe there are plenty of banks out there and there will be a functioning market that will be able to provide ample access to capital for CMBS,” he adds.
Access to CMBS loans will be an important factor for the real estate industry, given the still sizable wall of loan maturities that will be coming due in the coming year. Most respondents (61 percent) think the new rules will only slightly disrupt borrowers’ efforts to refinance 10-year CMBS loan maturities, while 20 percent believe it will severely limit borrowers’ ability to refinance, 15 percent anticipate no change and 5 percent said the new rules could help borrowers’ efforts to refinance maturing loans.
For borrowers that do need to refinance, it will be to their advantage to get out early as the risk retention rules could make CMBS capital more expensive. Whether issuers opt to use the vertical, horizontal or B-piece buyer exemption for risk retention, each will come with an adjustment related to the cost of funds that will impact pricing. “The reality is that that adjustment to pricing or cost to funds is going to be passed along to the borrower,” says DeRoy.
A majority of survey respondents believe it will take several months for CMBS market participants to completely adjust to the new rules. However, industry experts believe that the adjustment period will likely be much shorter, perhaps only a couple of months once the new risk retention rules go into effect. “Capital markets are an active, fluid process that tend to adjust quickly,” says DeRoy. “It is not like it is going to be a light switch. It is on and it works. There will be a small adjustment period, but it won’t be a prolonged period.”