Market Data

Maturing CMBS Market Looks to the Future

During the early 1990s the commercial mortgage-backed securities market came to life. Through 1998, this market continually saw exponential increases in the dollar-value volume of issuances in the United States. However, since 1999, the dollar value of issuances has plummeted. In 1998 approximately $78 billion of CMBS originated in the United States, but in 1999 issuances declined by 25 percent to $58 billion. In 2000, U.S. issuances again declined by almost 25 percent to approximately $45 billion.

This pattern of decline has many causes, including both cyclical and structural changes. Yet there is good news to report on the CMBS market and a positive prognosis for the future, both in the United States and internationally.

Cyclical Changes
Various real estate and capital market cycle factors affected the issuance of U.S. CMBS in 2000, including volatility in swap spreads, higher nominal interest rates, and fewer refinancings.

In early 2000, swap spreads were volatile. Some originators switched to pricing rates off of swap spreads instead of nominal, comparable term interest rates, since rising interest rates caused loans priced off interest rates to be less competitive when issued as CMBS. However, this caused the differences between swap spreads and interest rates to grow larger, which placed more cost risk on borrowers.

In addition, throughout 2000 the Federal Reserve pushed up interest rates, which affected the type of CMBS issued. Almost twice as many floating rate CMBS were issued during the year due to the rising rates.

Finally, since the general U.S. real estate recession began in 1990, conventional 10-year loans that originated during that year were far fewer than those issued in the 1980s, thus requiring fewer refinancings in 2000. Fewer refinancings meant less demand for new CMBS loans.

Structural Changes
Structural changes that occurred in the CMBS market in 2000 were more problematic and compounded the cyclical changes — many of which will be felt well beyond 2001. Structural changes included competition between originators, the number of buyers of CMBS B pieces, and a lack of success for the fusion strategy.

CMBS originators foresaw a decrease in potential CMBS issuances in early 2000; accordingly, they combined pools from different bookmakers into single, co-managed CMBS offerings. Some large CMBS issuers merged, including Chase Manhattan Bank and J.P. Morgan; Donaldson, Lufkin & Jenrette and Credit Suisse First Boston; and PaineWebber and United Bank of Switzerland. In addition, a number of other players exited the market, such as Capital Corp. of America and Prudential Securities. This consolidation trend will continue through the end of 2001 and beyond.

More importantly, the limited number of B-piece buyers resulted in more clout for this group, which caused numerous loans to be pulled from CMBS pools and many CMBS offerings to be pulled altogether from the market. While CMBS B-piece buyers have brought discipline to the market through their thorough underwriting analyses, nevertheless, they will continue to affect CMBS offerings through 2001. 

B-piece buyers are the institutions that purchase the subordinated class of bonds — the B pieces — associated with CMBS issuances. As such, they generally demand risk-adjusted returns greater than 20 percent. Likewise, they are sensitive to loans that may not have the track record, debt coverage ratio, or other factors that provide comfort. As such, B-piece buyers often compel up to 15 percent of a CMBS offering to be retained by the issuer, which results in less CMBS from which to sell and profit.

Finally, another striking change was the near rejection of the fusion strategy, which dropped by more than 90 percent in dollar value of CMBS issuances. Fusion generally refers to substituting collateral in the pool of loans. Buyers are not receptive to this structure due to the element of uncertainty in the pool, and it will have to be made more market friendly to succeed.

Future Growth
A recent positive development for U.S. CMBS issuers and issuances is a Department of Labor ruling that allows many traditional institutional investors to participate in subordinated securities, which results in more demand and potentially better pricing for borrowers and CMBS issuers. Also, major pension plans, which until now have been limited participants in the CMBS market, are expected to increase their activity. This will add more resources for analyzing and purchasing CMBS. These plan sponsors represent a huge pool of capital, and their eventual, broad-based participation should bring better pricing and liquidity to the U.S. CMBS market.

Overseas, the CMBS market is still in its infancy, yet it is experiencing explosive growth. Many U.S. bookmakers have dedicated significant resources to develop strategies and structures for secondary debt markets in Europe and Asia. Initial offerings generally have been single-asset or homogeneous pools; however, the market is now seeing multi-product, multi-jurisdictional offerings as well, such as the $1.3 billion offering underwritten by Rheinische-Hypovereins Bank and led by Barclay's Capital.

Asia will begin to play a more important role in supporting the increase in the global dollar value volume of CMBS issuances. In 2001, issuances are expected for Japan, Australia, South Africa, and Saudi Arabia, in addition to Europe. These markets should continue to grow considerably in the coming years.

Borrowers and lenders are optimistic about the future of the CMBS market, both domestically and internationally. Interest rates now are declining, which could stimulate demand for financings and refinancings. While swap spreads experienced renewed volatility in early 2001, a tightening spread should allow profitability for issuers and lower financing costs for borrowers. While U.S. volume may not increase dramatically by the end of 2001, offshore product volume will increase. 

The United States pioneered the use of public debt capital markets. It now is going through a phase of maturation, but it will continue to be a major component of the U.S. debt market. CMBS have not only influenced the entire debt market, but more importantly, they have helped to provide greater underwriting diligence and discipline to the flow of debt capital into real estate markets.

Jack Barthell

Jack Barthell is partner in charge of real estate capital markets at PricewaterhouseCoopers in New York. Contact him at (212) 596-7280 or


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