Texas Real Estate Business

MAY 2016

Texas Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in Texas.

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www.REBusinessOnline.com Texas Real Estate Business • May 2016 • 37 W ith the close of the frst quar- ter of 2016, the commercial mortgage-backed securi- ties (CMBS) and commercial real es- tate markets are a quarter of the way through the 2015-2017 wall of maturi- ties. Much has been made of the al- most $300 billion in 2005-2007 vintage CMBS loans coming due, including their performance at maturity and their efect on the overall market. So far, the story has been highly positive. Of the $80.9 billion in non- defeased, non-delinquent loans that were outstanding at the end of 2014 and due to mature from January 2015 through February 2016, 94.02 percent by balance has been paid of with 0.29 percent in losses. The remaining loans account for $4.84 billion outstanding as of this February, and 68.74 percent of those are marked as delinquent (in- cluding those marked as "Performing Beyond Maturity"). In 2012, maturing fve-year loans from 2007 came due and caused some ripples in the market. The U.S. CMBS delinquency rate hit its highest level ever in the summer of that year as close to $50 billion in 2007 loans came due in a still-recovering market. After another two years of price ap- preciation and fundamental improve- ment, including continued net operat- ing income (NOI) growth in all major property types, the market digested the heavy maturing volume of 2015 better than anticipated. New 2015 is- suance near $100 billion was enough to take on the refnancing of the $80 billion in 2015 maturities. Viewing the performance of 2015 maturities, solid aggregate NOI growth, and record commercial real estate price levels in a vacuum would lead to a very positive outlook for 2016 and 2017 maturities. Unfortunately, the bottom-up view of the market is only half of the story, and the negative macro factors com- ing from the top down could signif- cantly hamper the CMBS market's ability to handle the next seven quar- ters of increasing maturing volumes. Oil's slide since last year has ham- mered high-yield fxed income, bank balance sheets and energy company stocks. Pair that with the frst Fed- eral Reserve rate hike and growth concerns in China, and the result has been quickly widening new issue CMBS spreads. In the past few weeks, those spreads have recovered a decent portion of their losses but spreads re- main well wide of last year's tightest levels. Smaller conduit shops have pulled back from the market and the big lenders are hesitant to price loans given the warehouse risk in a volatile spread environment. Due to increas- ingly stringent capital rules and heavy regulatory costs, banks are cutting staf on trading desks and reducing their exposure to CMBS, leading to evaporating secondary market liquid- ity. Add a second potential Federal Re- serve rate hike in 2016 to those macro and regulatory headwinds and the outlook becomes slightly dubious for the more-than-$200 billion in non-de- feased, non-delinquent loans coming due between now and the end of 2017. Predicting Performance In order to get an idea of how the maturing loans may perform, we compared them to the most recent six months' worth of new conduit origi- nations based on cap rate, loan-to-val- ue ratio (LTV), debt service coverage ratio (DSCR), and debt yield. First, new DSCRs were calculated based on a simplifed "new" interest only loan based on property type/MSA-level average loan rates on recently origi- nated loans. Second, the maturing loans' appraised values were updated based on property type/MSA-level cap rates of recent originations. Third, current debt yields were calculated based on most recently available NOI data and current loan balances. Final- ly, new DSCRs and LTVs were calcu- lated for maturing loans based on sev- eral rate hike assumptions. For DSCR, the rate hike afects the loan rate di- rectly, increasing debt service and de- creasing DSCR. For LTV, the rate hike is assumed to infate cap rates and, consequently, decrease appraised val- ue and increase LTV. For debt yield, instead of changing the maturing loan debt yield, the threshold for qualify- ing for refnancing was raised by the assumed interest rate increase. Those measures were then com- pared to the average property type/ MSA levels of recent originations. The DSCR threshold was the easiest hurdle to jump. Based on current NOI levels of maturing loans, 85 percent of those loans (by balance) meet or exceed their respective DSCR thresh- olds. Current rates are around 100 to 200 basis points lower than they were back in 2006 and 2007; so maturing loans do have some breathing room on the DSCR front given the lower debt service burden of these new low rates. Given a 25-basis-point in- crease, 82 percent still meet the DSCR requirement and 68 percent pass the test given a 100-basis-point increase in rates. The story is a little bleaker when looking at the LTVs and debt yields of these maturing loans. Using current NOI levels and new loan cap rates (cap rate = NOI/appraised val- ue so new assumed appraised value = current NOI/cap rate), the new loan LTV threshold was much more restric- tive, eliminating about 43 percent of maturing loans from the "re-fnance- able" bucket. Further, only 52 percent of maturing loans meet their respec- tive debt yield thresholds assuming no change in rates. If debt yields jump 100 basis points, 59 percent of loans will fall below the minimum required debt yield. All of these calculations come af- ter removing maturing loans with negative NOIs and adjusting the re- fnancing thresholds to take MSA level values into account. Further, the MSA level values were only used when they were less restrictive (lower DSCR, LTV, and debt yield) to lower the bar for maturing loans. On a DSCR basis, almost $31 billion in maturing loans will not be able to refnance their entire balance. On an LTV basis, almost $93 billion would need additional equity in order to re- fnance at current income and cap rate levels. The number goes up to $100 billion if we apply the debt yield pa- rameter. This is not to say that all these loans outside of the recent CMBS origina- tion parameters will default. There are many on the margin that will either need non-CMBS lenders to provide higher leverage or sponsors willing to invest more equity. Bridge, mezz, and non-bank lenders are in a posi- tion to issue some serious volume in the next two years working on loans in that marginal area between totally refnance-able and those in need of some wiggle room. Commercial real estate prices have just plateaued and if they do begin to decline, the CMBS market will see maturity defaults rise and more loans go from CMBS to the bridge, mezz, and non-bank lending space. n Sean Barrie is a Research Analyst with Trepp LLC, which provides information, analytics and technology to the CMBS, commercial real estate and banking markets. CMBS SCENARIOS Debt yield and LTV hurdles put maturing CMBS loans at risk. By Sean Barrie

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