The securitised commercial loans market in the US is slowly returning to health. But its recovery has not been smooth. Lynn Strongin Dodds reports

The US commercial mortgage backed securities (CMBS) market looked like it was open for business in the first half of 2011 but then issuance declined as the euro-zone crisis reappeared in the summer and fears mounted over a double-digit recession across the pond. Tensions have since abated, but volumes have so far remained muted. Industry participants do at least expect to see a resurgence later in the year barring any unforeseen circumstances.

"Things had really heated up in the first six months of 2011, says John Wilcox, managing director of Savills in New York. "Pricing came in and lenders were more comfortable but things changed in the middle of the year because of things like Greece and the US hitting its debt ceiling. The number of participants shrunk very quickly and the CMBS market closed down. Conditions have incrementally improved this year in terms of pricing and acceptable property types. I think we could reach $40bn (€30.4bn) by year-end if there are no significant hiccups."

Tad Philipp, director, CRE Research at Moody's Investor Services is also optimistic that issuance will hit the $40bn mark. "I expect activity to increase during the rest of the year as spreads tighten," he says. "Freddie Mac, which has dominated the multi-lender sector, is estimated to account for around $15bn of total issuance. Around 70%, including the non-guaranteed portion of Freddy Mac, will come from conduit originators, while the balance will mostly be large loan, single-borrower, or floating-rate transactions. Several CMBS backed by non-performing loans will also appear for the first time since the mid-1990s."

Philipp believes that non-Freddy Mac issuance will be light in the first half of 2012 due to restricted conduit origination resulting from the euro-zone turmoil. However, he anticipates volumes will increase as loan spreads tighten. Spreads for CMBS and balance sheet lending programmes began 2011 roughly in parity, but ended the year with CMBS spreads wider by 50-100bps. The change in direction this year not only depends on the stability of the capital markets but also the risk appetites of investors.

"With issuance typically lagging conduit originations by several months, and with conduit originations lagging spread tightening, our issuance forecast has a greater margin of error than forecasts for which the year starts with a full pipeline and low spreads," Philipp adds.

The first quarter of 2012 did get off to a slow start although there were encouraging signs that investors regained their enthusiasm for a wider range of transactions. There was only $6bn-worth of deals from January through March, down 32% from a year earlier and virtually flat with the fourth quarter of 2011. However, the 11 offerings were more varied than in recent months. They included four multi-borrowers, three single-borrowers and the junior portions of four Freddie Mac issues.

By contrast, in 2009 when the market was beginning to revive, single-borrower transactions dominated the scene, followed by smaller multi-borrower conduit pools - ranging from 23 to 43 loans - in 2010.

The number and diversity grew in 2011, while floating-rate transactions, including large-loan pooled transactions, returned to the market. According to figures from S&P's, of the 30 non-agency transactions (those not backed by government-sponsored enterprises, such as Freddie Mac) originated last year, 18 were conduit transactions compared with six of 15 transactions in 2010. Prices also recovered, rising by a hefty 387.4% to $24.7bn in 2011 from $5.08bn in 2010, while the average transaction size jumped 62.5% to $1.37bn from $845.8m.

The days of the jumbo deals are over, acording to Mitchell Kiffe, senior managing director and co-head of US debt production at CBRE. "There is still a demand for the typical fusion (conduit) deal where there are number of loans - 70-100 - in the price range of around $1-1.5bn," he says. "The days of the $3bn to $5bn transactions are over. One reason is that investors are conducting greater due diligence, which is impossible the mega transactions. The smaller deals are much more manageable. We are also seeing large single-borrower deals, such as the recent Deutsche Bank office transaction in New York."

Single-borrower CMBS differ from so-called multi-borrower conduits in that they are typically linked to one property, such as an office building or hotel, or to one loan tied to several different properties. In most single-borrower transactions, parties are able to put up more equity and therefore may get better terms on the loan versus placing the loan into a conduit with multiple loans tied to different properties.

In February, the German bank sold $625m of CMBS supported by a loan on an office building in New York owned by billionaire Sheldon Solow and commanding some of Manhattan's highest rents. The triple-A bonds were priced to yield 2.6%, or a spread of 110bps over interest-rate swap rates. More recently, UBS kicked off the second quarter with a $412m single-borrower CMBS backed by the Fontainebleau Miami Beach Resort. The five-tranche transaction contained one triple-A slice, for $254m, with a 5.05-year weighted average life.

JP Morgan priced a $125m deal for Silverstein Properties backed by a loan on the Seven World Trade Centre building in Manhattan, while Bank of America Merrill Lynch and Deutsche Bank priced a $324.8m deal for OSI Restaurants, the owner of informal restaurant chains. That offering was collateralised by one fixed- and floating-rate loan on 261 restaurants.

However, market uncertainty remains a threat while regulatory uncertainty poses the other biggest challenge facing the market, according to Kiffe. This includes questions over how Dodd Frank will be implemented, risk retention and subordination levels. "The issue of rating agency reports and their inconsistencies also needs to be addressed," he adds.

While views may differ on the final outcome of the impending rules, all agree the CMBS market is unlikely to return to those halcyon days when issuance soared, reaching its zenith of $233bn in 2007. Instead, many in the industry believe it will revert back to its roots as a financing tool and eventually settle into the $75-100bn region.

As Philipp points out, CMBS issuance is largely driven by acquisitions and spreads in
the capital markets, in contrast to the steadier pace of balance sheet originations. This explains why volumes ballooned during the golden years and then quickly contracted when those conditions reversed.