Page 15

CRE Finance World, Autumn 2013

A publication of Autumn issue 2013 sponsored by CRE Finance World Autumn 2013 13 widespread belief that rates are going up and that it’s got to be attributable lock step to an improving economic outlook and improving job market trends. The disconnect is that the rates we’ve observed over the last couple of years are not consistent with the level of growth that we’re experiencing. The rates we’re observing in the market are substantially lower than what we would normally see for the current level of growth. And that has been a reflection of significant intervention on the part of monetary policy makers. So we have this initial increase in rates that we might normally attribute to a better set of underlying fundamental drivers, but that might not actually be the case at all. It’s why the unqualified argument about wide spreads is flawed. Lisa Pendergast: That’s a very good point. Growth has certainly been sub-par, but it’s been there. It’s not the 3%+ that everyone wants to see, but it has been sufficient, especially combined with Fed-inspired historically low rates, to enhance the refinance-ability of once marginal legacy loans. Mitch or Larry, any thoughts? Larry Brown: I’ll throw out an observation: you can see we’re in a different environment because for the last two and a half years, everything has been LTV constrained. For the last 60 to 90 days you’re actually hearing the words uttered, ‘debt service coverage constraint.’ It’s new and different, but it does show that the landscape has changed just a little bit. You have to keep your eye on it, and what it does to the finance-ability of assets. It means there is a new benchmark now that there is the DSC constrain — not for all deals, but it is out there now. Lisa Pendergast: Samir, maybe you can talk a little bit about what you think the market is going to do. What are your views on current underwriting? Do you anticipate further deterioration? Do you stay in the sector, and if you do, do you reallocate to something you feel more comfortable with? Samir Lakhani: Underwriting is certainly trending in a direction of higher total debt leverage and looser standards. It might not always come through in outright metrics but we are certainly seeing more loans with weaker structures like partial or full IO terms, or concentrated roll near maturity. This can exacerbate negative loan outcomes in what is already expected to be a more difficult refinancing environment. That being said, one point to highlight is that currently, the securitization machine is not nearly as geared as it was pre-crisis. Pre-crisis, whether it was a cell-tower, casino, or restaurant transaction, we saw a lot of corporate transactions dressed up in CMBS clothing. We are not there yet. Yes total leverage is creeping up, which is worth paying attention to, but right now it feels more balanced across markets and product types. Lisa Pendergast: What does a higher-rate environment do to the very large pool of outstanding legacy CMBS? Do investors continue to focus on legacy knowing of the so-called ‘wall of maturities’ that lies ahead and the impact the inability to refinance some of these loans will have on bond values? Or do you re-focus your attention squarely on the new issue market with improved underwriting and asset-level upside in most cases? Samir Lakhani: Because they are at two different parts of the curve, you could end up with a mix of both. Legacy product, as it shortens in maturity will become less of a beta-trade and likely more reactive to news headlines on individual loans. That’s where you are going to have to cull through you portfolio and keep those stories you like. With any fixed income portfolio, there is some element of replacing product being refinanced with new-issue product, but because they are at very different parts of the curve, there is room to own both. Lisa Pendergast: And I think you hit on something interesting. If you look forward to when 2005 through 2008 legacy loans secured by well sought-after trophy assets began to mature, the new loans that result will make for very attractive collateral for new CMBS deals, assuming underwriting standards remain reasonable. Samir Lakhani: Agree, and I think just this year we saw close to one-third of the issuance in single-borrower, single-asset product. I think it’s easy to argue that many of these loans are higher quality than many of the loans going into conduits and you will have a natural supply of that a few years forward as these trophy assets come back to market in single-borrower form or as a portion of future conduit transactions. Lisa Pendergast: Let me change gears and talk about the lending environment, as competition certainly has grown. What are you finding today? Has the increased competition caused a degradation in underwriting standards? Already, most market participants agree CMBS underwriting has slipped since the early stages of the recovery but still remains considerably more conservative compared to the peak in the market in 2007. Greg Michaud: Well one of the reasons why we are out competing heavily on longer-term loans like 15-, 20- or 25-year loans is that there is little or no competition from the GSEs or conduits in this space. So that’s where we’re most competitive. As we go shorter, and get around 10-year loan request, life companies will be competing with the conduits and GSEs who are really competing on loan proceeds. As loan requests get shorter than 10 years, we CRE Finance World Roundtable: Macro Issues Facing CRE Finance “The securitization machine is not nearly as geared as it was pre-crisis. Pre-crisis, whether it was a cell-tower, casino, or restaurant transaction, we saw a lot of corporate transactions dressed up in CMBS clothing. We are not there yet.”


CRE Finance World, Autumn 2013
To see the actual publication please follow the link above