From Datsun to Nissan
Last week, commercial real estate professionals (~1,200) around the nation gathered at the GW Marriott in DC to attend the CREFC (formerly known as CMSA) conference braving snow, horrendous local drivers, and no-touch strip clubs. Like a spiritual retreat, attendees came to reflect upon the current status and inner child of the commercial real estate market including topics of CMBS V2.o, market liquidity, senior class investor rights, special servicer rights, and, everyone’s favorite boogeyman, government regulation…
In 2008 & 2009, CMBS issuance ground to a halt with the market meltdown and credit tightening causing spreads to widen from S+15 (Last Cash Flow Super Duper AAA) to S+1,200. By 2010, CMBS came back from hibernation and roughly $8B of private label CMBS was issued using extremely tight credit underwriting. The first quarter 2011 CMBS deal pipeline is $13B of new issue as spreads continue to tighten to S+150ish level. Securitizers improved disclosures and structural mechanisms to lure back AAA investors. For instance, deal advisors, who review all the actions of the special servicer on troubled loans on behalf of the senior debt holders ,and appraised losses (for control rights) to the deal (affecting lower rated tranches).
The pendulum swings
The hallmark of CMBS v2.0 is the structural changes and tight underwriting such as high debt-to-service coverage ratios (DSCR), low LTVs, and net operating incomes (NOI) calculated on *gasp* actual cashflows (unlike the $3B Peter Cooper Village/Stuyvesant Town defaulted loan). Tight credit underwriting enticed investors to buy and brought liquidity back into the market. Money, which had been on the sidelines for ages (2 years), returned and investment bank conduits re-engaged in the business. Now the problem of sourcing new loans under this tight credit box creates angst for the deal makers as only roughly $55B of CMBS mortgages (many poorly underwritten) matures this year and no new mega construction projects. Mortgage supply is tight. Conduits will, inevitably, lower their underwriting standards to source loans until investors balk. Given the collective memory of investors, we should be back to pro-forma (i.e. NOI based on projected or make believe cash-flows) underwriting in less than nine months.
Some the new features of CMBS v2.0 will probably go away over time as both issuers and investors stop paying for CMBS safety features.
- Investor advisors cost money and no one will want to pay for them.
- Special servicers will want their rights back.
- Investment grade investors will rely on the B-piece buyer for underwriting due diligence.
CREFC participants expressed an optimism for their markets not seen since 2007. Investors are buying. Delinquent commercial mortgages are being sold in bulk. Loss severities are manageable. Prices are up. WAY up since last year. Economic fundamentals are improving (with exception of that pesky unemployment). Nothing could go wrong right?
Most participants worry about the yet to be determined regulatory environment as financial regulators create the rules around disclosure, reporting, risk retention, capital reserves (Basel II & III), FASB 166/167, alternatives to ratings and FSOC. All of these various regulatory activities will increase the cost of securitization and possibly make issuance prohibitively expensive. CREFC wants to ensure regulators treat CMBS with a very light touch. Clearly CRE professionals’ amnesia of 2005-2007 disasterous underwriting knows no bounds. The structured finance market placed the bullets in the chamber and shot itself and the US economy squarely in head. CMBS wasn’t the worst offender (RMBS and CDOs were) but it had some very large newsworthy blowups.
Secondly, participants worried about the massive spread tightening over the last 12 month. They believe the CMBS market is due for a major correction. Spread widening will hold up many deals which are profitable only by a few ticks. Keep in mind, delinquencies are still rising though at a slower rate. Should this trend reverse, expect significant spread widening in a very short amount of time.
From the “You Gotta Be Kidding Me” department
- Investment bank CMBS research analyst hopes rating agencies can maintain better credit judgement now that two new companies entered this space. Clearly the economics of the rating agencies have been fixed. NOT.
- From an investor, “The government will prevent bad underwriting.” Like gov’t regulators actually understand commercial underwriting. NOT.
- “CMBS is just fine and don’t mess with us Mr. Big Bag Regulator government.” Tell the 11,000 families living in Peter Cooper Village/Stuyvesant Town wondering how much more they will have to pay for maintenance?
- “Regulators should not have capital be based on the credit of the asset.” Wow! Did a Tex Avery double take on that comment.
For your reading pleasure:
In my opinion the best two CMBS analysts are Alan Todd of JP Morgan and Roger Lehman of BoA/ML
AND STAY OFF MY LAWN!