40 / 72
CRE Finance World Summer 2015
38
with top tier sponsors,” commented Matt Borstein, the Head of
U.S. Lending for Deutsche Bank, the most active U.S. CMBS loan
contributor in 2014 and thus far in 2015.
Where are the Risks?
Having enjoyed fairly consistent spread and origination improvement
since 2009, where are the current risks in CMBS? Our panelists
saw CMBS as having substantial stability and generally better
asset quality than CMBS 1.0 but saw the major risks facing CMBS
as fourfold:
A Bolt from the Blue.
Everyone saw “A bolt from the blue” as the
greatest risk facing the CMBS market and the hardest to predict/
prepare for. All acknowledged that we are living in an increasingly
volatile world and that despite strong underlying fundamentals,
CMBS could experience significant price fluctuations from various
“outside” events whether the collapse of the Euro, a terror event, or
the price of oil.
Interest Rates.
While everyone expected rates to be “range bound”
for some time and any increases to be fairly well announced and
gradual, all expressed concern of the unintended consequences
of a sharp and sustained spike in U.S. interest rates for CMBS.
Discipline.
Substantial concern existed regarding the market
“losing discipline.” Post financial crisis, the CMBS market and its
participants, whether investors, dealers or rating agencies, have
been conservative and disciplined in their asset selection, underwriting
and investment approach. All panelists registered concern about
losing discipline using phrases such as “slippery slope”, “bracket
creep” and “boiling frogs” to express their trepidation.
Third Tier Assets.
Concern was raised about the potential impact
of the third tier assets on loss severities in CMBS, particularly
during the “wave of maturities” in 2016/7 and the echo impact that
may have on CMBS, generally.
Concerns were generally forward looking and focused on items
beyond the market’s control such as interest rates and a bolt
from the blue. All took comfort from the strength and stability
of underlying property fundamentals as well as the maintenance
of discipline, across the board, at least for the time being. “While
discipline is here at the moment,” commented Rich Sigg from Bank
of America Merrill Lynch, he also noted that, “as investors stretch
for yield, they continue to move further out on the risk spectrum
and into increasingly “cuspy” investments.”
We’re all globally connected
CMBS, though mostly a U.S. asset class, has gone global, post
financial crisis. CMBS are purchased by foreign investors, the
underlying assets are owned by offshore buyers, valuations are
impacted by international interest rates and monetary flows,
unconnected to U.S. property valuations, can significantly impact
CMBS prices and investors’ performance.
Top Tier U.S cities and properties, as noted previously, are playing
catch-up to the international market, in terms of rental rates and
valuations, and still have a long way to go. These new valuations,
driven by offshore comparables, are changing property valuations
across the country — positively for the “haves” and negatively for
the “have nots”. CMBS investors will need to carefully monitor
these trends.
How far new offshore valuations of U.S. property will reach, and
their impact on CMBS, is unclear. However, all agreed that foreign
capital appears to have found a permanent and growing home in
the U.S. and that foreign dollars bring overlays of exogenous factors
such as foreign currency, interest rates and political stability/instability
as dynamic overlays into the property and CMBS markets.
Conclusions
The CMBS market is in a good place. New issuance is matching
maturities and the overall size of the market has stabilized and
begun to grow again. Delinquencies continue to decline, loans in
special servicing are likewise decreasing and the “wall of maturities”
is being whittled away, assisted by a historically low interest rate
environment and by a global quest for yield. On the other hand,
valuations are reaching all-time highs and global inter-connectedness
is creating heightened volatility. Overall, four major themes emerged
from our informal CMBS roundtable of market participants:
1. CMBS is part of a globally interconnected financial world,
impacted by many factors unrelated (for better or worse) to the
underlying health or performance of CMBS or its collateral;
2. Volatility is on the rise and with many indices at record highs
(such as the Dow Jones, Class A office prices) or record lows
(such as interest rates, the price of oil, and the Euro), CMBS is
impacted by sharp changes in these markets;
3. Continued discipline — by investors, issuers and rating agencies —
will be essential to the continued health and prosperity of
CMBS; and
CMBS 2.0 — State of the Market 2015