Since that time, of course, the market cratered in the aftermath of the 2008 capital markets crisis, and in recent years has seen analysts lower their expectations for new issuance volume. During the same time frame, the number of CMBS loan contributors doubled, growing from 18 in 2011 to 37 last year, with a concomitant decline in credit quality, write Flohr and Jacobs.

Now the pendulum is swinging back toward a smaller roster of lenders—a contraction that Flohr and Jacobs see as “healthy for the market,” favoring well-capitalized institutions “with a tenured history in CMBS lending and broad origination forces.” This lender contraction won't drive up borrowing costs, they write, “as borrowers will still have an array of financial institutions and capital sources from which to choose.

The perennial challenge of certainty of execution will continue to be a concern this year, “at least until the market finds its footing,” according to the PGIM white paper. “Lenders will only lend if they are confident they can sell the loan. That said, lenders with combined lending and B-piece buying arms will have a competitive advantage.”

As for the B-piece buyers themselves, Flohr and Jacobs foresee potential gains for a select group of them. “In the near term, a lack of capital able to satisfy risk-retention rules could lead to outsized returns. Longer term, the regulations could reduce competition and present a tremendous opportunity for well-capitalized B-piece buyers with a strong reputation and longer investment horizons.

“Qualified B-buyers will also have a greater incentive to improve CMBS pool credit quality upfront given the required capital commitments and the fact that their payout will be highly correlated to the payoff of underlying loans in a CMBS pool,” write Flohr and Jacobs. “This should lead to better risk-adjusted returns.

CHICAGO—It's been said that the risk-retention piece of CMBS securitizations going forward will stymie the market for a debt instrument that already is struggling to cross the $100-billion barrier. The argument is that the new rule, requiring a CMBS sponsor or qualified third party to retain 5% of a deal's value on the books, “will restrict capital, drive up borrowing costs, increase execution uncertainty around new loan originations and push smaller financial institutions out of the market.”

That's how a new white paper from PGIM Real Estate Finance summarizes the pessimistic view of risk retention, which took effect this past December as part of the Dodd-Frank regulatory regime. However, the white paper then makes the case that not only is CMBS poised for a new bloom of popularity, but that the risk-retention requirement will help the cause, as well.

As the latest NCREIF Property Index makes clear, equity appreciation has been decelerating, a trend that means “borrowers will likely look to take on higher leverage levels to hit yield targets,” according to the PGIM REF white paper, titled “Not So Risky Business: Why Risk Retention Regulations Are Good for the CMBS Industry.” This dynamic is gathering momentum at the same time as banks are hemmed in by new regulations when it comes to providing higher leverage loans.

“Since banks may be restricted and insurance companies are continuing to be cautious in lending, CMBS loans will likely become an attractive financing option for borrowers needing higher leverage,” according to the white paper, whose principal authors are Richard Flohr, managing director, capital markets, and principal Alison Jacobs. 'It's worthwhile to note that the CMBS market has historically been an important capital source for borrowers needing higher leverage, especially in secondary and tertiary markets. This need, combined with a flat credit curve that made CMBS an inexpensive source of incremental leverage, propelled the growth of the CMBS market in the early- to mid-2000s.”

Since that time, of course, the market cratered in the aftermath of the 2008 capital markets crisis, and in recent years has seen analysts lower their expectations for new issuance volume. During the same time frame, the number of CMBS loan contributors doubled, growing from 18 in 2011 to 37 last year, with a concomitant decline in credit quality, write Flohr and Jacobs.

Now the pendulum is swinging back toward a smaller roster of lenders—a contraction that Flohr and Jacobs see as “healthy for the market,” favoring well-capitalized institutions “with a tenured history in CMBS lending and broad origination forces.” This lender contraction won't drive up borrowing costs, they write, “as borrowers will still have an array of financial institutions and capital sources from which to choose.

The perennial challenge of certainty of execution will continue to be a concern this year, “at least until the market finds its footing,” according to the PGIM white paper. “Lenders will only lend if they are confident they can sell the loan. That said, lenders with combined lending and B-piece buying arms will have a competitive advantage.”

As for the B-piece buyers themselves, Flohr and Jacobs foresee potential gains for a select group of them. “In the near term, a lack of capital able to satisfy risk-retention rules could lead to outsized returns. Longer term, the regulations could reduce competition and present a tremendous opportunity for well-capitalized B-piece buyers with a strong reputation and longer investment horizons.

“Qualified B-buyers will also have a greater incentive to improve CMBS pool credit quality upfront given the required capital commitments and the fact that their payout will be highly correlated to the payoff of underlying loans in a CMBS pool,” write Flohr and Jacobs. “This should lead to better risk-adjusted returns.