By Billy Fink
After weathering the financial markets meltdown in 2007, CMBS is back to - almost - business as usual. The sector has regained its credibility as an important source of capital for commercial real estate, with U.S. CMBS issuance surpassing $100 billion in 2015.
So, what's ahead for CMBS in 2016? The answer to that could be simply more of the same. Fitch Ratings' 2016 Outlook for CMBS predicts a market that will be stable in the coming year. Stable might also be synonymous with flat and, let's face it, boring. But boring is a welcome forecast for a sector that has seen its share of hard knocks in the last few years and still has some challenges looming ahead.
It hasn't been all smooth sailing in the post-recession era - what many now refer to as "CMBS 2.0". The market has seen healthy, but definitely lower, levels of issuance. U.S. issuance has been climbing modestly higher in recent years, with 2015 issuance reaching $106.2 billion - up nearly 13 percent compared to the $94.08 billion issued in 2014, according to Commercial Mortgage Alert. However, the industry is still far below peak levels in 2005-2007, when annual issuance ranged between about $166.5 billion and $228.6 billion.
There is also some pricing uncertainty for CMBS heading into 2016. Spreads have been widening in the past six months, particularly among non-investment grade securitizations. For example, the last deal of 2015 (JPMCC 2015-JP1) priced wider than expected. The deal split the lowest investment-grade tranche into one BBB and one BBB- class with a weighted average spread of 520 basis points over swaps, according to Trepp. That is notably higher than the 52-week average for BBB- issuance at 410, according to Commercial Mortgage Alert. This may be telling the market that B-piece buyers are wary of the risk and want a bigger return in exchange for taking on that risk.
Those wider spreads do translate to higher costs for borrowers. But that has not been much of a deterrent. Borrowers typically like CMBS because they can get higher leverage than other sources of capital, such as a bank or life insurance company.
In its 2016 forecast, Fitch also pointed to some "warning signs" that could emerge in the coming year. Although Fitch noted a year-over-year decline in underwriting, the ratings agency does expect underwriting to stabilize in 2016. According to Huxley Somerville, a managing director and head of Fitch Ratings' U.S. CMBS group, the market is likely to see greater stability as some smaller issuers pull out of the market and the large issuers pay close attention to loan quality.
Generally, Fitch also expects underlying fundamentals to remain stable across property types. However, hotels and multi-family are two sectors that will be subject to scrutiny in 2016, as those sectors are near peak income and NOI levels. Ratings agencies will be watching how lenders are underwriting loans in those sectors to make sure the levels are sustainable for the 10-year cycle of the loan.
There is certainly the potential for CMBS issuance to climb higher in 2016 with a wave of CMBS loan maturities in the pipeline from 10-year loans that were done in 2006 and 2007. Yes, there is a possibility that issuance could surge beyond modest growth to hit some big numbers. However, given the increasing competition and pricing pressure in CMBS, the sector may be content to settle for another year of good, steady, boring growth.