The recent below par pricing of two Goldman Sachs arranged CMBS deals demonstrate the potential perils of CMBS as a distribution tool for CRE debt. Indeed, these two deals bring into stark focus the pricing quandary that currently confront many conduit lenders. On the one hand, lenders are having to competitively price loans in a debt market that is awash with a plentiful supply of liquidity leading to increasingly tighter margins, meanwhile the capital markets have proved themselves to be anything but predictable. A balance sheet lender (or a lender seeking to distribute a loan via the syndication market) can be largely indifferent to short term volatility in the capital markets which is subsequently corrected, however, as demonstrated by the impact of a potential Grexit and the Chinese stock market crisis on the below par pricing of the Logistics UK 2015 CMBS and the Reitaly Finance CMBS, short term market turbulence has the potential to have a profound impact on lenders with a CMBS exit in mind.
With the continued fallout from the global financial crisis, uncertainty regarding the Eurozone, falling oil prices, increasing instability in the Middle East as well as the unknown impact of rising interest rates, it is likely that we will increasingly be confronted with periods of extreme volatility in the capital markets. Although market turbulence will certainly not be welcomed by CMBS lenders, it is nevertheless one of the endemic risks of employing an originate-to-distribute business model with CMBS at its heart. Despite the fact that this risk cannot be entirely eradicated, there are certain mitigants that lenders can use to limit pricing risk such as ensuring the temporal period between pricing of a loan and distribution is kept to an absolute minimum. Equally a lender could ensure that its exposure to a large loan is reduced by syndicating an amount of the loan contemporaneously with origination. Finally (and it is noted that this is easier said than done), a bank can avoid being placed in the unenviable position where it is forced to launch a CMBS deal amidst tumultuous capital market conditions in order to free up balance sheet or meet investor demand for product.
When it comes to the origination of large loans, this pricing risk is magnified and further compounded if there is little or no appetite to distribute any amount of this loan in the syndication market. In these circumstances, a lender should be mindful of another weapon up their sleeve and that is the arrangement of an agency CMBS deal pursuant to which the borrower can directly tap the capital markets to raise debt (see Agency CMBS – the sophisticated tool for raising cheaper commercial real estate debt!). Although such structures will not afford originators the right to receive excess spread, they will at least allow banks to meet both borrower and investor demands whilst at the same time not having to deploy any of their balance sheet. At a time when the capital markets are likely to be prone to periods of heightened volatility and lenders are reluctant to assume significant pricing arbitrage risk, when it comes to the origination of large loans we could therefore yet see the renaissance of agency CMBS technology with renewed vigour as a means of satisfying borrower, investor and lender requirements alike.