CMBS professionals are expecting the rule of supply and demand to positively impact CMBS bond prices in the first quarter of 2017. We previously reported that most CMBS issuers cleared out their inventory in anticipation of risk-retention rules effective December 24 (see our 12.7.16 article). This will leave dealers with little inventory of new CMBS loans that can be pooled into CMBS securities going into 2017. In addition, interest rates on CMBS conduit loans have increased roughly 50 basis points (bp) since the U.S. presidential election, dampening borrower enthusiasm to proceed with new CMBS loans right now.
Investors in CMBS securities — mainly banks, insurance companies and pension funds — typically get new CMBS investment allocations at the beginning of each new year. So these investors will be flush with fresh cash to invest in CMBS. With limited new issue CMBS supply, it is likely that there will not be enough CMBS securities to go around. As a result, when new CMBS deals are announced, orders for the CMBS bonds will exceed the amount of bonds available; deals will be “oversubscribed,” in bond parlance. When deals are oversubscribed, issuers typically tighten the spread and allocate the securities on a pro-rata basis. So if a buyer places an order for $2 million of AAA-rated CMBS and the class is 2x oversubscribed, the buyer will be allocated $1 million at the tighter spread with an option to drop out altogether if the new spread is unacceptable.
If subsequent CMBS deals continue to be oversubscribed, which is a strong possibility for the first few months of 2017, issuers will continue to tighten spreads until supply and demand come in balance. If the scenario of strong demand and limited supply does play out to tighten loan spreads, it will be a welcome relief to CMBS borrowers. “I think the lack of supply will result in CMBS spreads declining roughly 25 basis points across the board,” indicated one CMBS pro “resulting in a similar decline of 25 basis points in CMBS borrower rates by February.”