For Borrowers And Investors, CMBS Resurgence Presents Opportunity

The embattled commercial mortgage-backed security is once again on the rise, after falling out of favor as a financing source after the financial crisis. The new generation of CMBS is better-serviced and regulated, and represents a product that investors and borrowers both feel more confident in.

In their pre-recession heyday, commercial mortgage-backed securities lenders were the chief drivers of CRE financing. Distrust and uncertainty among investors persisted long after a recession that depressed asset prices and cast a shadow over loan repayment prospects. Borrowers grew fatigued with an inflexible workout process. Pervasive default risks and constricted credit caused CMBS lending to decline precipitously after the financial crisis.

Risk retention rules, which stipulate banks vest interest by retaining a certain percentage of these instruments on their balance sheets, have reduced the amount of available credit and restricted loans to higher-leverage and tertiary market borrowers. Since these rules, aimed at checking rampant loan origination, require banks have sufficient capital reserves, the new CMBS volume is even more impressive.  

In the first two quarters of this year, $47.4B of new CMBS debt was issued, up from $37.9B in Q1 and Q2 2016. According to data compiled by Trepp, 335 loans worth $10.65B originated in August alone.

1. When The Space Is Competitive, Borrowers Win

There is a glut of capital stagnant on the sidelines waiting to be allocated to deserving projects. When banks compete with each other to deploy capital to a limited stock of worthy loan candidates in a low-interest-rate environment, it creates an ideal situation for borrowers.

Borrowers who take advantage of the chance to lock in low rates with long-term loans effectively hedge against future disruptions to the economy and capital markets.

2. Investors Will Enjoy Higher Returns And Portfolio-Balancing Benefits 

A higher degree of selectivity also benefits investors, whose analysts are advising to start offloading positions laden with pre-recession CMBS at high risk of default. Current credit support levels, coupled with improved property collateral metrics including loan-to-value and debt-service coverage ratios, make CMBS bonds an attractive investment alternative to other MBS products. As CRE-oriented investment vehicles, they have the advantage over REITs of a specified date by which investors realize returns.

One benefit of CMBS is that they are highly correlated to U.S. macroeconomic movement, and thus attractive for investors looking to insulate themselves against volatility caused by Brexit or foreign shocks to the market.

As of April 1, Bloomberg included the entire U.S. Aggregate Index in its Global Aggregate Index, encompassing smaller, previously excluded CMBS tranches, increasing CMBS demand and upside potential.

3. CMBS Service Has Evolved And Improved Dramatically 

Borrowers’ experiences with CMBS have historically been fraught with complaints of poor customer service from servicers.

KeyBank, a leading CMBS provider, is especially cognizant of this lingering negative public perception, and is pioneering solutions to change it. It has enhanced its customer service systems to ensure employees are available to interact with borrowers. Better-served customers will be more capable and diligent when it comes to repayment.

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