A publication of Winter issue 2015 sponsored by CRE Finance World Winter 2015 13 A major difference between this cycle and the last cycle is the way the decline in standards is being treated by the rating agencies. In 2006-07 subordination levels declined as loan standards worsened. Today, the agencies have responded to the loosening of standards by increasing subordination levels. “I like the positive correlation as opposed to negative correlation,” Smith said. “If the originators make worse loans, the investors should get more credit enhancement; that’s supposed to be the trade-off.” Cheng said that higher subordination ultimately serves to reduce the profit of issuers, which could incentivize them to write better loans. Role of B-Piece Buyers Asked whether it was a good time to buy junior bonds at a time when loan quality was slipping, Parkus said his firm was still comfortable as long as Seer was given sufficient flexibility with the collateral pool. Though he added that “there is no question that collateral quality is headed in one direction — down.” Parkus also said that investors should differentiate between larger banks and more established players who, for the most part, have been better at holding the line on loan quality, and a subset of the new, nonbank originators who have allowed loan quality to slip significantly. The best time to buy junior CMBS is during the early part of the cycle. “On the whole we believe we are still in an acceptable part of the credit cycle, but that view might change over the next year or two,” he said. Role of Rating Agencies Cheng noted that rating agency reports have become more detailed, with his agency among those that provide much more detailed information than was provided by agencies in CMBS 1.0. For example, Morningstar is one of the agencies that provides asset summaries about the Top 20 loans in pools. Agencies typically only highlighted the Top 10 loans in CMBS 1.0 deals. Asked whether he approved of the additional information in presale reports, Smith said investors have information overload and likened researching multiple deals to triage: “It doesn’t hurt (to have more information), but the velocity of deal flow makes it difficult to get through it all.” Smith said investors are asking for standardized “best-practice” term sheets amongst the various CMBS shelves to make the investor’s job more efficient, likening the current disclosure situation to that of a “Rubik’s cube or puzzle.” Bunch said that regulation 17g-5, which requires agencies to set up password-protected websites that detail ratings methodology, was a “huge positive” because it deterred ratings shopping and disciplined issuers to provide full information to each agency. Panelists applauded the trend toward issues carrying split ratings. Smith gave it “two thumbs up,” saying it created discussion about why agencies give different subordination levels to the same collateral. Bunch said that issuers have to consider split ratings in terms of economics versus how each shelf wants to represent itself to the market. Conclusion Given the nature of the industry — banks write loans on commercial real estate and sell them to investors — it should be no shock that the issues involved don’t change dramatically, and probably won’t even when the market gets to CMBS 10.0 and beyond. The real question, as several panelists noted, is whether the market learns from past mistakes and takes action to not repeat them. In some ways, lessons have been learned. As noted by Bunch, a great deal of leverage has been removed from the financial system, since investors no longer buy bonds on credit. But there still is no way to change the fact that the market is competitive and lenders will go to great lengths to win loans. “For me, the biggest concern is to reduce the fluctuations inherent in CMBS,” Overby said. “We don’t know what the next crisis will look like.” CMBS 3.0 Seminar: Same As It Ever Was?
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