The New Lending Rules that Have Developers Worried

These are notes I took on an interview regarding Basel III regulations and its impact on lenders and borrowers of construction financing;

High Volatility Commercial Real Estate (HVCRE) Loans – A designation primarily for construction loans provided by banks. Proposed Basel III regulations will require higher reserves for loans with a HVCRE designation. Another implication of the HVCRE is that internal returns generated by the project must be kept within the project. For instance, after completion of the asset but before stabilization of the asset, there will likely be a period of positive cash flow. This provision will have onerous tax consequences on REITs, which are required by their tax designation to distribute a substantial portion (approximately 90%) of their taxable income to shareholders. 

Additionally, Basel III regulations will a have dampening effect on IRRs which impacts how cash flow is distributed among investors, and may dissuade investors from taking on certain construction projects altogether.

A construction loan will avoid the HVCRE designation provided it meets the following criteria:

1. 15% of the capital is contributed as unencumbered equity;
2. Maximum of 65% LTV; and
3. Keep capital contributed in the asset, including equity and NOI.

The new rules apply to loans new and old, however these regulations are still being negotiated.

Fitch Downgrades or Withdraws Ratings on Distressed Classes in 11 U.S. CMBS Transactions

Fitch Ratings has taken various rating actions on already distressed U.S. commercial mortgage-backed securities (CMBS) bonds. Fitch downgraded 24 bonds in 10 transactions to 'D', as the bonds have incurred a principal write-down. The bonds were all previously rated 'CC' or 'C', which indicates that losses were considered probable or inevitable.

Fitch has also withdrawn the ratings on three classes in one transaction as a result of realized losses. The trust balances have been reduced to $0 or have experienced non-recoverable realized losses and are no longer considered by Fitch to be relevant to the agency's coverage.

KEY RATING DRIVERS

Today's downgrades are limited to just the bonds with write-downs. Any remaining bonds in these transactions have not been analyzed as part of this review. In cases where the last rated tranches of a transaction are in default and rated 'D', the defaulted ratings will be automatically withdrawn within 11 months of the date of the previous rating action.

A spreadsheet detailing Fitch's rating actions on the affected transactions is available at 'www.fitchratings.com' by performing a title search for: 'Fitch Downgrades or Withdraws Ratings on Distressed Classes in 11 U.S. CMBS Transactions', or by clicking on the link above.

RATING SENSITIVITIES

While the bonds that have defaulted are not expected to recover any material amount of lost principal in the future, there is a limited possibility this may happen. In this unlikely scenario, Fitch would further review the affected classes.

CMBS Loan Values Down in 2015 Due to Higher Rates

The price of the loans underlying commercial mortgage-backed securities declined 210 basis points during 2015, amid a broad rise in interest rates, according to DebtX.

The estimated price of the whole loans securing the CMBS universe was unchanged from November to December at 97.6%.

"CMBS loan prices dropped 210 basis points primarily due to a rise in interest rates across the yield curve and a widening of market spreads across all collateral types," Will Mercer, managing director of the Boston company, said in the release.

DebtX priced $900 billion of commercial real estate loans that collateralize U.S. CMBS trusts through the end of December, according to a Monday news release.

The median adjusted loan-to-value ratio increased to 58% in December, the median debt service coverage ratio increased to 1.47 and the median estimated loan yield rose to 4.6%.

November S&P Summary

• It was a relatively quiet month in U.S. equities. U.S. large-cap dispersion fell modestly in November to 5.6% as it continued to move within a tight range. U.S. small-cap dispersion remained high even in comparison to longer-term averages.

• A similar picture held across most developed markets; the exception was Australia, which has seen its equity markets battered by external forces in recent months. This month, a return to bearish form in commodities saw dispersion in the S&P/ASX 200 rise to its highest levels in two years; correlations also rose in a month of relatively elevated volatility 'down under.'

• Excepting Australia, correlations were largely unchanged across our developed benchmarks and declined (along with volatility) in China and the S&P Emerging BMI.

CMBS delinquencies edge up in October

The delinquency rate on commercial-mortgage backed securities jumped slightly in October, but the story continues to be that bubble-era loans backing CMBS are being refinanced and paid off, Morningstar Credit Ratings reported.

The delinquency rate increased two basis points to 3.51 percent, but remains 64 basis points below the level of one year ago, Morningstar reported.

Analysts have been concerned about a wave of highly leveraged loans in CMBS that were originated during a period of looser standards between 2005 and 2007.

In its latest surveillance report, however, Morningstar said that the principal balance of CMBS declined by $9.97 billion in the month, an indicator that payoffs on 2005-to-2007 era loans are picking up.

The delinquent balance fell to $27.67 billion in October, down 13.6 percent in one year, Morningstar reported.