CMBS 3.0 Seminar: Same As It Ever Was? magine walking into a CMBS discussion about: The role of rating agencies and credit enhancement. Transparency and the level of loan-level information provided to investors. The impact of government regulations. B-piece pricing and loan selection. The deterioration of underwriting. Now a question: during what time period did this conversation take place? A) CMBS 1.0 (1990s through 2010). B) CMBS 2.0 (2010 through 2014). C) CMBS 3.0 (today). D) All of the above. Of course, as every market player knows, or at least those old enough to remember the 1990s, the answer is “D,” all of the above. These issues as they relate to today’s CMBS market were the subject of a CREFC after-work seminar held Oct. 24 in Manhattan, moderated by Nomura executive director Lea Overby. The panelists were: Leland Bunch, managing director at Bank of America Merrill Lynch; Richard Parkus, managing director Seer Capital Management; Adam Smith, director at Deutsche Asset & Wealth Management; and Ken Cheng, managing director at Morningstar Credit Ratings. Regulation Debate New risk-retention rules will require the holders of the subordinate 5% of CMBS pools to retain the bonds for five years, which prompted a variety of reactions from the panel. Bunch called it “shocking” that there will be rules that would limit investors’ liquidity. That would particularly affect floating-rate deals, because they typically mature in five years or less. Bunch said the rule means that buyers of junior floating-rate bonds will be required to own bonds to term, calling it “preposterous.” The lower liquidity ultimately will increase the cost of capital, push up loan rates, increase rents for tenants and reduce the value of CMBS, he said. Smith, however, said investors like the idea of issuers eating their own cooking, noting that issuers “date” loans only for a short time, while investors “marry” them for the length of a securitization. CRE Finance World Winter 2015 12 Because the rule doesn’t take effect for two years, the impact will be muted because the market will have time to adjust. “We won’t wake up in two years and say, ‘holy cow, what are we going to do?’” he said. Overby said CMBS might ultimately follow the model of the creditcard securitization market, in which issuers retain the bottom 5% of deals. Whatever the impact of risk-retention, it will be greatest on B-piece buyers, who own the bottom 5% of most deals. Most B-piece buyers aim to be long-term holders. Parkus noted that though there is a wide variation in strategies employed by B-piece buyers, some do in effect eat their own cooking by partnering with issuers and regularly buying the bonds from the same group of issuers. Panelists discussed the delicate dance between issuers and B-piece buyers to avoid “kick-out” loans that are rejected from deals by the junior bondholders. If issuers are putting together a pool and find out that the B-piece buyer will reject a particular loan, the closing of the loan is likely to be delayed or put off entirely. “We spend a lot of time constantly discussing” collateral with B-piece buyers, Bunch said, “to make sure we don’t do something stupid.” Frothy Underwriting There was no dispute that underwriting took a sharp turn for the worse around mid-year. Among the symptoms are the rising amount of interest-only loans, some loans underwritten with pro-forma assumptions and a growing amount of conduit loans with construction elements. The trend coincided with a surge in the number of lenders competing for loans. Bunch noted that specialty lenders accounted for 4-5% of CMBS during the market peak, and that has risen to about 20% today. They have taken share from insurance companies and some commercial banks, while conduits are at the same percentage. That is no accident, since reducing the commercial real estate exposure of banks was one of the intentions of banking regulations, he said. I Paul Fiorilla
CREFW-Winter Edition
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