Freeze, thaw, chill, repeat.
The CMBS market — a key source of financing for commercial real estate — has been on a wild ride in recent weeks as the broader financial markets have skidded and surged.
Commercial mortgage-backed securities largely track the stock market: When investors get nervous, such as about rising interest rates causing a recession, they pull their money out of risky assets like stocks and mortgage bonds and pile into the safety of U.S. Treasuries.
This can grind markets like CMBS to a near standstill, which happened this summer before a stock market rally helped open the spigot back up. CMBS issuance is expected to fall short of last year’s $109 billion, despite a strong first half of 2022, according to Trepp.
All this can make things confusing and difficult for borrowers seeking CMBS loans.
Manus Clancy, Trepp’s head of data and research, spoke with The Real Deal to break down what’s happening with CMBS. This interview has been edited for clarity.
We hear things like “the CMBS market has ground to a halt,” which sounds dramatic — like the 2008 credit crunch. What does it mean when people say the market’s frozen?
CMBS has really gone through some serious pivots over the last six to 10 weeks. The market was really kind of muddling along really until that shocking [inflation] report came out in June. People freaked out and pulled back. We went a month and a half without seeing any new CMBS conduits priced.
Over the next six weeks, liquidity started to improve and people started putting money to work again. We saw two or three conduit deals price and then it dried up for a short period of time.
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Why did it pause?
Banks get nervous as to whether they can sell the loans at a profit. The business model is to lend and hedge right away against interest rate moves and spreads widening. When times get extremely volatile, the banks worry that they’re going to get stuck holding these loans, so they pull back. That’s what we saw in the middle of June.
Did the banks end up selling loans for a loss?
That’s a tricky question. Every bank has to report on securitization whether they made or lost money. Recently the banks have been saying they’ve been losing money on securitizations… somewhere in the low single-digits, like 2 to 3 percent. But that’s not really representative of what’s happening because it only reflects what they made the loan at and what they sold it for. When you consider they’re hedging against interest rate moves, they’ve probably all done small profits.
What does this all mean for borrowers? Does volatility make loans more expensive?
When volatility picks up, you have one of two things happen. The first is the banks say, We’re going to pull out. You’ve seen that happen three times in the last 15 years: during the Financial Crisis, in 2016 when oil went to $26 a barrel and during the first months of Covid.
It pivots so quickly. Nobody wants to be caught long when everybody’s selling and they don’t want to be sitting on cash when everybody’s buying.
The other way it can play out is that to compensate for the greater volatility, the banks are going to lend at significantly higher rates. If the spread had been 200 basis points, maybe they’re now going to quote a 250 basis point spread. We saw that from June until a few days ago when the stock market started to bounce back. There has since been renewed volatility in the equity markets and banks are back to being a little more cautious.
How much of the commercial mortgage market runs through CMBS?
The number people throw out there is something like 15 percent. I think in 2007, when we saw enormous issuance, it was probably closer to 20 percent.
If borrowers can’t access CMBS, where do they turn?
It opens the doors for banks and insurance companies to pick up some of the slack. CMBS issuers have to be laser-focused on clearing these loans at a profit. They have to react to market moves immediately and widen their spreads as volatility picks up. Banks don’t have that same immediacy. Their thinking is, if we like this credit yesterday and we like the return we’re getting, we can move at a time when CMBS does not want to move. The same is true for insurance companies.
How are delinquencies trending?
They dipped again last month and they’re now in the low 3 percent range. The July number is a new post-Covid low. The expectation is that delinquencies will go higher over the next six months. People are expecting that rates are going to be higher and because borrowers will reach their refinancing date, they’ll have to pay more. I don’t think there will be an explosion — more like a modest uptick.
What do you think happens in the near future?
I think the markets will ebb and flow. Everybody seems to be moving to the same cadence. When the narrative flips to “we don’t have inflation under control and the Fed is going to have to be more aggressive and we’re going to have a recession,” everybody moves to one side of the table. They panic and put money into short-term Treasuries because no one wants to get caught holding assets. But the minute confidence changes and people think we can navigate a soft landing and a recession will be modest, nobody wants to miss out on returns either.
It pivots so quickly. Nobody wants to be caught long when everybody’s selling and they don’t want to be sitting on cash when everybody’s buying. The sentiment is so unanimous in either direction when it happens. Everybody runs to the right and then everybody runs to the left.
Have you ever seen volatility like this?
We’ve had more volatile periods. 2008 was more volatile. The early days of Covid was more volatile. What we’ve seen in past crises is that there’s a market sell-off and then somebody jumps in and makes a lot of money and everybody else says, Why didn’t I jump in sooner? Now I think the slightest sell-off, the slightest dip, everybody plows in. Each downturn, that period of time it takes people to go from panic to exuberant gets shorter and shorter.