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January 13, 2014 3:48 pm
A bond backed by a homeless shelter would not, at first glance, appear to be the stuff of investors’ dreams. But as demand for debt backed by commercial mortgages has soared in recent months, yield-hungry investors are rushing to snap up new deals that bundle up loans to non-traditional properties – from data centres to water parks.
Increased competition to originate loans has spurred lenders – from banks to members of the so-called “shadow banking system” – to seek out new types of assets to bundle into commercial mortgage-backed securities (CMBS).
CMBS sales surged to $102bn last year – their highest level since the financial crisis and a 15.6 per cent increase on 2012’s issuance, according to data from Dealogic. But the increased issuance has coincided with concerns about slipping underwriting standards as well as the securitisation of new types of loans.
“When there’s a lack of product and a lot of people chasing it, you’re bound to see some less traditional assets,” says Keith Kockenmeister, managing director at Kroll Bond Ratings. “You have to take each one on a case-by-case basis.”
One of the more eye-catching examples is a bond sold by Citigroup which is backed by 137 commercial mortgages. The bond includes a loan to 127 West 25th Street, a homeless shelter whose location in the fashionable Chelsea neighbourhood of Manhattan has raised the ire of some of the area’s residents. The bond was sold last year but has not previously been reported.
Another deal, put together by the commercial real estate lending arm of Cantor Fitzgerald, included a loan to 60 Hudson Street, the former Western Union Building which has now been converted into a data centre that houses computer systems.
The same bond includes a loan to Kalahari Resort and Convention Center, a chain of African-themed waterparks.
While originators seek out unorthodox assets to securitise into CMBS deals, there are concerns about the return of pre-crisis lending practices.
Pro forma underwriting, where originators estimate the future cash flows of a property on optimistic projections rather than current rates, has crept back into the market, according to some commercial mortgage brokers who connect property developers with lenders.
“Different folks have different perspectives on what they believe ‘pro forma’ is,” said Eric Thompson, senior managing director at Kroll. “There is a clear line though – and if originators are giving credit to rental revenue that is not in place and/or above market rates it is pro forma, and we have seen some of that.”
Interest-only loans, another hallmark of pre-crisis lending practices, have also returned.
“It’s clearly back,” said one mortgage broker. “We’re seeing aggressive competition and it’s probably warranted.”
That competition is being driven by new entrants to the commercial lending arena, including non-bank lenders, and by banks who are making more aggressive corporate loans as they seek to boost their profit margins, according to analysts and rating agencies.
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