Tepid demand for triple-A CMBS tranches is keeping deal sizes smaller, panelists said during a bond investor panel at the CRE Finance Council’s annual conference in New York City this week.
Size really does matter when it comes to conduit CMBS, as smaller deal sizes prompted by tepid investor demand — particularly on triple-A tranches — will keep issuance from reaching the peaks of the boom years.
Despite the post-recession rebound in US CMBS issuance, with more than $100bn in total expected this year, investor appetite for conduit CMBS is “not near the level during the previous legacy period,” one bond investor said during the CREFC panel discussion.
“It’s a product of being more selective and also being more guarded about liquidity if everyone were to run for the exits at the same time,” one panelist said.
There was about $192bn in conduit CMBS issuance in 2007 compared to just $56bn in 2014, according to data Trepp provided for this article. But the reason for the discrepancy was not so much the number of deals as it was their size. The data shows there were 61 deals with an average deal balance of $3.145bn in 2007, while 2014 saw 50 deals with an average balance of just $1.143bn.
There has been about $26bn in CMBS conduit issuance so far this year, with average deal sizes continuing to reach that $1.1bn or $1.2bn range. So, when do deal sizes begin to creep up to $1.5bn or $1.6bn, $2bn… or $3bn? Not anytime soon, panelists said, as tepid demand, particularly for triple-A tranches, is keeping deal sizes smaller due to perceived unfavorable spreads and total returns.
“Dealers will not go there right now,” one speaker said. “They’ve found a sweet spot in the $900m to 1bn size deal. They don’t want to take on too much warehousing risk, and quite frankly there’s a struggle to sell all the $300m in triple-A that they have to sell.
“I don’t see issuers willing to try and supersize the deal they are already struggling with. I thought, with rates backing up the way they have in the last couple of weeks, there would be renewed demand for better-yielding triple-A, but they’re constantly stuck in the mud.”
Additional concern comes with the fact that some of the loans contributing CMBS pools are of even worse quality than those from the legacy period. As a range of new originators enter the space, there will be as many as six loan contributors on a deal, the panel moderator noted, pointing to a recent Fitch Ratings report that noted disparities in underwriting standards between large, small and non-bank US CMBS originators, leading to an “overall decline in credit quality in recent months.”
A Fitch analysis of 30 originators found that the largest banks have the strongest credit metrics, while smaller banks or non-banks have the weakest; and that CMBS investors are becoming increasingly concerned about credit quality as the number of originators continues to grow.
“The smaller originators out there have higher delinquency rates, a higher percentage are on the watch list — on legacy, and it’s even worse in terms of 3.0 performance — so I think that speaks volumes,” one panelist said, echoing that sentiment.
“Not surprisingly they have higher costs to capital than a bank would, so by nature they will be making riskier loans,” he went on. “And they’re serving markets that are generally the underbelly of the market, or markets people don’t want to be in. They certainly serve a place for liquidity in the market; I just don’t know if these should be CMBS loans.”
“The non-bank issuers are not good diversification,” added Antony Wood, executive vice president, sector head CMBS, with Hartford Investment Management. “It’s just a weaker set of loans with weaker structures.”