CRE CLO Issuance to Remain Flat in 2019
Despite a slowdown in CRE Collateralized Loan Obligation (CLO) issuance over the last six months, industry participants expect activity to pick up and ultimately result in flat volume of $15B to $17B to end 2019, noted several panelists at IMN‘s 1st Annual Investors’ Conference on CRE CLOs.
CRE loans in CLOs often provide floating-rate, short-term bridge financing to borrowers looking to make improvements to their properties. The borrower’s goal is to raise rents or occupancy, and therefore generate higher property income. Once the property is stabilized, borrowers will often look to secure long-term, fixed-rate financing.
Fed Policy Change Impacts CLO Market
“As we saw in the fourth quarter of last year there was a bit of a market pullback. There was some volatility and some spread widening, and we’ve seen that carry over into the first quarter of this year,” observed Michael Barbieri, Vice President at Goldman Sachs. Issuance so far this year is $2.5B, he said, which is slightly up year-over-year but slower than what some expected.
The market slowdown was largely driven by the Federal Reserve’s change in policy direction regarding interest rates, panelists said.
“The big story in the last 12 to 18 months has been long-term interest rates,” added panelist Jon Brayshaw, Principal at Prime Finance Partners. Investor appetite for CRE CLO bonds grew last year because of their shorter duration.”
This was at a time when investors thought the Fed would continue to raise rates significantly. However “by the end of the year, as the Fed started to signal a shift in policy, I think that was part of what has had an impact on this market and muddied it a little bit,” he added.
Fellow panelist Shannon Stotts, Managing Director at Resource Real Estate, agreed that the beginning of 2019 was a “tough start” for the market. There was less deal flow after a huge year in 2018. She added that new lenders are accessing the CLO space, which will likely contribute to flat issuance this year.
Motivations for Accessing the CLO Space
Issuers and investors alike are utilizing the CLO market for a variety of reasons. On the issuer side, the CLO market is attractive because it’s becoming a more accepted financing vehicle that is often non-recourse, noted Steve Baumgartner, Chief Product Officer at Trepp LLC. For investors, CLOs often provide higher yields and are less sensitive to interest-rate volatility than fixed-rate loans.
“There’s a healthy dynamic in the market…investors and participants are taking an active role in keeping together a market that is functioning well,” added Nitin Bhasin, Senior Managing Director at Kroll Bond Rating Agency.
The CLO market is also appealing because it has been performing well despite being in the late stages in the current cycle. Delinquencies are low and prepayments are “relatively robust as business plans are executed,” Baumgartner noted.
“That could change given the overall macro picture. But so far collateral performance has been good and there have been limited losses to the deals that have come post-crisis.”
Borrowers Increase Pre-Payment Activity
Bhasin added that another recent trend in the market has been a large number of prepayments given the financing is short term and interest rates remain low. Multifamily had the fastest prepayment speeds, he said, because the loans are often smaller than those for other property types.
These loans are also often on Class B/C properties, which continue to be in high demand as the new supply of multifamily properties has largely been Class A properties, according to Kroll Bond Rating Agency’s recent report.
Arbor Chairman and CEO Ivan Kaufman agreed that this trend is observable in the company’s business. “Our floating-rate pipeline is fairly healthy, with borrowers prepaying their short-term financing in order to transition into the fixed-rate market sooner.”
He added, “if you’re a transitional lender, you want people to execute their business strategy. If they execute it a little earlier and if the fixed-rate markets are open and interest rates are favorable, that’s really beneficial to both the borrower and the lender.”
At Arbor, originators offer pre-payment flexibility in order to help borrowers carry out their business plans for their properties and form a long-term relationship with them, Kaufman noted. “It’s all about the relationship.”