Conduits: past, present and very much the future

Real Estate Weekly, June 25, 1997 by Michael Landau

Historically, the CMBS market was the domain of Agencies, REITs, RTC/FDIC and larger single asset borrowers, rather than the final home for your typical office, retail or hotel loan. In fact, in 1994, less than two billion dollars or 7 percent of the CMBS market was issued by the conduits, (the Well Street firms who pool, bulk and then sell the portfolios of the smaller, i.e. less than $30 millon loans).

By the end of 1996, while the overall CMBS market increased by nearly 40 percent, the conduits' share of the market had increased from seven percent to about 35 percent, with the conduits' dollar volume up from below $2 billion in 1994 to almost $10 billion in 1996, a staggering 500 percent increase in two years.

Previously untapped product types, such as industrial properties, grew from almost no securitizations in 1994 to almost $1.5 billion in 1996. Hotel securitizations increased from barely over $0.5 billion in 1994 to almost $3 billion in 1996, an almost 600 percent increase. Retail facilities increased from below $3 billion in 1994 to about $7 billion in 1996, and office building securitization increased from below $1.5 billion to approximately $5 billion in 1996.

What we are witnessing are two major trends in the commercial lending arena. First, that the single asset-lending conduits have become the dominant factor in the CMBS market, and second, that there has been a marked diversification in the property types that are being securitized.

In order to predict the trend for the foreseeable future, it is necessary to try understand the evolution to date. At the risk of oversimplifying complex economic issues, I would suggest two underlying trends.

The first is the availability of money in the capital markets. Until recently, with large budget deficits, the Government was issuing almost one trillion dollars of debt annually. This year's deficit, estimated in the one hundred billion dollar range, leaves almost a trillion dollars that would otherwise have found a comfortable home in the treasury market, looking for a secure resting place. The CMBS provides such a facility to the risk averse investor, thus we have seen the overall CMBS market grow over 400 percent since 1990.

The second trend is on the real estate front. As a result of major losses incurred in recent years in this sector, we have witnessed the demise of the commercial banks and life companies as the answer to the genetic commercial mortgage request. The conduits, having access to the capital markets, have risen to the challenge of filling the void and are providing the funding for the commercial mortgages. The role of the conduit in originating commercial mortgages is far more limited in the scope of their underwriting, which is generally focused on assuring that the loan meets the rating agency guidelines rather than reviewing the loan on its individual merits.

The number of active conduits has risen dramatically in the past two years. This increased competition had widened the product mix offered to the borrower, as well as expand the qualifying criteria into the programs, thus making it even easier to secure financing from one of the conduits.

This trend, I believe, will continue and strengthen over the next couple of years, with the conduits increasing their market share of the CMBS market, as well as expanding the product types for which CMBS financing will be available.