4.3.12: What’s the Direction of Debt Yield on CMBS 2.0 Issues?

Since the restart of the CMBS market in June 2010 when JPMorgan issued $716 million of CMBS, market participants have focused on a metric called debt yield.  Debt yield is the property net cash flow (generally defined as actual income and expenses including management fees less capital reserves regardless of whether actually incurred) divided by loan amount.  Debt yield for a CMBS issue would be the weighted-average debt yield for all the underlying properties.  CMBS professionals believe debt yield is a better measure of leverage compared with debt-service coverage ratio because debt yield recognizes that in low interest-rate environments, a property may exceed the required debt-service coverage ratio for the loan amount, but may not be able to refinance at maturity if cash flow has not improved and rates are higher when the loan is refinanced at maturity.

When analyzing CMBS issues, debt yield is an excellent metric as it is possible to have two CMBS issues each with a weighted-average debt-service coverage ratio of 1.50x, but with two different risk profiles that can be identified through debt yield.  Suppose one pool has a weighted average interest rate of 7% and the other 5%.  The debt yield on the 7% pool will be higher than the 5% pool, indicating the 5% pool has a much greater balloon refinance risk than the 7% pool.

In 2010, there were six multi-borrower CMBS issues.  The weighted-average debt yield is currently 13.44%, a benchmark for low leverage.  At the other extreme, the debt yield for the benchmark legacy (pre-2008) CMBS issue GSMS 2007-GG10 is currently 6.94%.  In 2011, there were 18 multi-borrower CMBS issues with the average debt yield of 11.22%, a significant reduction from 2010 levels as the market became more comfortable with CMBS risk.  In 2012, four multi-borrower CMBS issues have average debt yield of 11.44%, indicating that debt yields are remaining relatively steady in the mid-11% area.

“We are buying CMBS 2.0 for our affiliated bank, Country Bank, and we are using debt yield in our bond analysis,” said Jim Brett, CMBS analyst and loan underwriter for ValueXpress.  “We are comfortable with deals that have debt yield north of 11%; hopefully, underwriting does not loosen to allow debt yields to fall below this level.”

This entry was posted in CMBS, CMBS Securities, Commercial Mortgage-Backed Securities, Michael D. Sneden, News & Recent Closings, The Banker's Mortgage Conduit, Valuexpress and tagged , , , , . Bookmark the permalink.

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