New CMBS Retention Regs May Not Be So Bad for CRE Lending Market After All

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New Potential Buyers, Lenders Emerge as First CMBS Risk Retention Deal Hits the Street

This week, a new but not unexpected wrinkle emerged in what has been a volatile and tentative CMBS market.

While overall CRE lending has been strong, securitization activity of commercial-backed loans has been subdued. In addition to market volatility, CMBS analysts attributed the drop-off in CMBS activity to new federal regulations taking effect at the end of this year governing retention of some loan risks by lenders and originators.

This week, the first CMBS risk retention deal hit the street, adding a little more uncertainty to what it means for CRE financing and CMBS investing.

The $870.6 million CMBS conduit is backed by loans from 46 properties. Per the new guidelines, the loan originators are each expected to purchase and hold a 5% portion of retained interest.

Other than the 5% retained interest, the loan is structurally the same as current CMBS deals, prompting one analyst to refer to it as ‘CMBS 3.0-RI.’

Analysts originally expected the new regulations would add costs for investors, which in turn would lead to fewer buyers and less demand, eventually contributing to tighter financing for CRE deals.

But that thinking is starting to change. As early as six months ago, there were concerns that there would not be enough B-piece buyers to support the new CMBS structures, according to Kroll Bond Rating Agency. But the higher yields available from CMBS is beginning to attract more interest.

“In addition to some existing B-piece buyers, we are aware of six (new) players that intend to enter the market, all of which have significant industry experience and have the ability to raise capital,” analysts at Kroll Bond Rating Agency noted this week.

Also, several major non-bank institutional lenders are considering becoming CMBS issuers, as opposed to contributing loans to issuers. Driving that demand is the low yield being offered by bonds. B-Piece offerings in CMBS deals, on the other hand, can generate returns in the high teens, Kroll Bond analysts said.

Higher Cost to Do Business

Mark Gibson, CEO of HFF, noted that while he expects to see more CMBS lending, the added costs under the new regs makiing originators hold 5% of the deal could benefit larger firms with deeper pockets and force out smaller players.

It’s “going to result in the larger getting larger and the smaller players unable to compete without a significant balance sheet given the risk retention roles that we’re seeing,” Gibson said.

The other impact expected from the new federal oversight regs is a shift to financing higher quality collateral. If originators have to keep ownership of 5% of a deal, they may be less willing to the higher risk of owning lower-quality properties.

At the very least, it could halt the deterioration in credit quality that the CMBS market saw in the fourth quarter of last year, analysts said.

The loans in the new CMBS pool incorporating the new ownership retention requirements (WFCM 2016-BNK1) is a collateral pool backed heavily by loans for several major property types. The 10 largest loans make up almost 60% of the offering. The properties include The Shops at Crystals (9.2% of the offering), a 262,327-square-foot luxury retail center in Las Vegas that sold this past spring for $1.1 billion. Other top five loans include Vertex Pharmaceuticals’ headquarters in Boston (9.2%), One Stamford Forum in Stamford, CT, (8.2%), Renaissance Dallas (6.9%) and Pinnacle II in Burbank, CA (4.6%) – all Class A properties.

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