Kroll Bond Rating Agency (KBRA) releases its CMBS Outlook: Floating into 2019.
In the report, we provide reviews and forecasts for issuance activity, property market fundamentals and credit ratings. One of the major highlights in 2018 was the popularity of floating-rate paper issued for both single borrower (SB) and commercial real estate collateralized loan obligations (CRE CLO) deals.
Yield hungry investors appear to be taking advantage of rising interest rates with short-term paper, which also can have the additional benefit of limiting potential pricing erosion associated with fixed rate instruments in a rising rate environment. On the other hand, borrowers seem to want the additional flexibility of short-term loans, particularly on transitional properties, which can offer favorable, or no prepayment provisions.
Of the SB deals year-to-date through November 2018, 76% of them consisted of floating-rate paper compared to 58% in 2017. Although investors have been favoring floating-rate SB deals, they have been coming recently with higher leverage when compared to fixed-rate SB deals as well as 2017 floating-rate SB. We expect that SB deal issuance in 2019 will be near the low end of our 2018 forecast of $35-40 billion.
Conduits will experience a year-over-year decline again in 2019 to $30 billion from our 2018 forecast of $35-40 billion. We expect the decline in conduits will be due to fewer loan maturities, a competitive lending environment, and a continued rise in the 10-year treasury rate which could further dampen the attractiveness of refinancing a loan.
We are also forecasting that CRE CLO issuance, which consists of almost all floating-rate loans, in 2018, could almost double 2017 issuance of $7.7 billion, and end 2019 at about $15 billion. This will be due to a number of factors, including a smaller number of new entrants to the sector as well as the challenges with sourcing loans which have experienced declining margins in 2018.
We saw a rise in interest-only loans primarily due to the increase in full-term IO loans. In addition, KBRAs capitalization rate increased to 9.36% from 9.23% in 2017, likely reflecting the increased CMBS exposure to secondary and tertiary markets. However, according to JLL, an investment management company providing commercial real estate services, the share of transaction volume in primary markets has been ticking up after three consecutive years of decline. This could be the result of investors focusing on more liquid markets given the late stage of the CRE cycle.
We expect the upgrade to downgrade ratio to compress, reflecting more downgrades as a result of where we are in the CRE cycle. While we anticipate that most of the negative rating activity will occur on speculative grade ratings, some investment grade ratings, particularly in the lowest investment grade categories, are likely to experience negative actions as well.
Please feel free to reach out to us with any comments or questions on our 2019 CMBS Outlook.
To review the report, please click here.
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KBRA is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus, is recognized by the National Association of Insurance Commissioners as a Credit Rating Provider, and is a certified Credit Rating Agency (CRA) by the European Securities and Markets Authority (ESMA). Kroll Bond Rating Agency Europe Limited is registered with ESMA as a CRA.
Larry Kay, Senior Director
Eric Thompson, Senior Managing Director
Pramit Sheth, Senior Director