The trend of putting ever-smaller pieces of the same commercial mortgages into multiple securitizations requires investors to be extra careful.
Large CMBS loans are being carved up to spread risk
risk-retention and other regulations under the Dodd-Frank Act have led to subtle but significant changes in the way commercial properties are financed in the securitization market.
Large trophy office buildings, shopping malls and hotels are typically funded in this market because the exposure would be too big for any one bank or insurance company. Their size dictates that these mortgages either serve as collateral for a single bond offering or be split into multiple notes collateralizing two or more transactions on a pari passu, or equal-footing, basis.
But the Dodd-Frank rules increased the cost of funding, re- sulting in lower overall issuance of commercial mortgage-backed securities, as well as a decline in the average size of CMBS deals backed by multiple loans, known as conduits.
As a result, even some not-solarge loans are increasingly being carved up into smaller, bite-size pieces. Last year, $26 billion of loans tracked by the credit rating agency DBRS were split into close to 500 pieces and bundled into collateral for various mortgage bonds.
“It used to be there was no problem putting a $100 million loan into a conduit,” said Erin Stafford, a managing director at DBRS. “But the average conduit transaction is now around $1 billion,” limiting the size of loans that can be used as collateral without increasing concentration risk of a given pool.
One problem with the trend of pari passu issuance is that when these loans go bad, as some surely will, workouts will inevitably be more complicated than they would be for a whole loan.
In the meantime, pari passu loans have become so endemic that investors putting money to work in more than one CMBS conduit need to pay close attention, lest they end up placing bigger bets than they want.
“When a large loan is split into so many deals, you can easily end up with too much exposure to that property when you buy tranches of several conduits,” said Teresa Walters, a vice president in portfolio management at Amundi Smith Breeden. “In some recent transactions, more than half of the top 10 loans are pari passu loans.”
The problem is acute for investors buying a lot of CMBS in a short time.
“If there’s a deal with a portion of a large loan, maybe the next five deals are going to have exposure to that loan as well. So you have to be particularly careful,” Walters said. “But if you buy one deal now and then wait a few months to buy another, the likelihood is that the rest of the loan will already have been put into other deals.”
In one example, a $325 million mortgage on the Fresno Fashion Fair Mall, in Fresno, Calif., was split into six notes, ranging in size from $39 million to $80 million, placed in as many conduits between October 2016 and March 2017, according to DBRS. The loan, which the property owner Macerich Co. obtained from JPMorgan Chase and Societe Generale, is backed by 536,093 square feet of the 957,944-squarefoot shopping center.
Very large loans, those over $ 250 million, can still be securitized on their own. Goldman Sachs recently completed two of these transactions, which are known as single- asset, single- borrower CMBS: a $465 million mortgage backed a portfolio of 10 office