CMBS Issuance to Shoot Up in 2015, but Sliding Underwriting Standards Pose a Risk

CMBS Issuance to Shoot Up in 2015, but Sliding Underwriting Standards Pose a Risk

As many industry experts predicted, CMBS issuance in 2014 overshot 2013 levels, but that may not be an entirely positive development.

As of last week of December, Commercial Mortgage Alert, an industry publication, estimated that U.S. conduit shops originated $90.5 billion in new CMBS loans in 2014, up 5.1 percent from $86.1 billion the year before. A 2015 Outlook Survey, conducted by the CRE Finance Council, an industry trade group, forecasts that CMBS issuance this year will increase by approximately 25 percent, with 70 percent of survey respondents expecting total issuance to range between $100 billion and $125 billion. (The survey polled 77 industry companies.)

This will likely correspond with an increase in balance sheet lending and lending by private sources, according to survey results.

All this may be good news in view of the upcoming debt maturities. According to Fitch Ratings, 2,580 CMBS loans totaling $36.4 billion will reach the end of their terms this year, increasing the need for refinancing options.

The issue is that the quality of underwriting on the new CMBS transactions has been eroding, including a proliferation of interest-only loans, an increase in leverage ratios and a drop in debt service coverage ratios. Fitch researchers report that from year-end 2013 to year-end 2014, there has been a 42 percent increase in partial interest only loans among the deals the firm has reviewed, a roughly 20 basis points increase in leverage ratios (from 65.5 percent to 67.4 percent) and a change from debt service coverage ratio of 1.67x to 1.59x.

Smaller originators, including Starwood Financial, Rialto and CIBC World Markets, were more likely to offer higher leverage ratios than players such as Bank of America, Wells Fargo and Barclays.

And as the industry moves in 2015, underwriting standards will only get worse, according to 88 percent of CRE Finance Council’s survey respondents. Industry professionals are most concerned about rising LTV ratios, followed by lower debt yields and an increase in interest only loans.

Looking forward, CRE Finance Council President and CEO Stephen M. Renna cautioned lenders about the importance of keeping underwriting standards grounded in reality.

“Industry participants see another year of positive growth for commercial real estate debt markets, as ample capital and credit should be available to meet borrower demand and pending loan maturities,” he said in a statement. “This is buoyed by stronger overall economic growth and a trend of improving property fundamentals. However, for growth to be sustained it is critical that the industry demonstrate underwriting discipline in the face of abundant capital and heightened competition.”

As of December, the delinquency rate in the U.S. CMBS market totaled 5.75 percent, a five basis point decrease from the month prior, according to New York-based research firm Trepp LLC. It was also 162 basis points lower than the CMBS delinquency rate a year ago. The percentage of loans that were seriously delinquent also dropped three basis points, to 5.63 percent. The delinquency rate was highest for loans secured by multifamily properties, at 8.85 percent, followed by loans secured by industrial properties, at 7.55 percent. It was lowest for loans secured by hotels, at 4.77 percent.

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