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CRE Finance World, Autumn 2013

line is that, in the fourth quarter 2013, it doesn’t feel like a free-for-all YET to me, and it doesn’t feel like we’re hurtling toward a free-forall. It feels like it was more aggressive than it was a year ago, but not unhealthily so… YET. And you notice I keep saying the word “yet”, because it’s on all of us — the entire CMBS community — to keep things on track and learn from the mistakes of the mid-2000s and be grateful as heck that we still have a thriving industry to be stewards of. Mitch Resnick: One thing I want to add is, looking from 2009 to 2012, the pendulum has swung pretty far. Early on, it was pretty conservative to the point where credit was squeezed too tight. So you kind of only had one direction to go. But, how much further does it go from here. I do see us losing on credit underwriting issues occasionally, although not all NOIs are created equal. I do think that future regulation could cause people to play with the NOI numbers. That is a possibility. But it’s important to acknowledge that aggressive underwriting is something that can be an issue but if folks are incentivized to go that way, if there is no check on the system, then that’s the way it’s going to go. Right now, when we lose, I lose on pricing sometimes, but we lose more on credit and loan structure than anything else — items like interest only, leverage, borrower structure and lockout provisions. Lisa Pendergast: Samir, from an investor perspective, what do you think about new lenders? Do they help or hinder the overall quality of the end product? In many cases, the new lenders are just the old conduit lenders under a new name, but there are definitely brand new lenders on the scene. Is that a good thing? Samir Lakhani: You certainly get more of a selection with that. But I think by definition, when you have an increased number of originators and an increased number of B-buyers, more collateral can get through, and with competitive pressure that can include weaker loans. That means investors have to be more selective as to which deals they are participating in. Frankly, I think that touches on another point, which is that I don’t think there has been all that much differentiation across a lot of these new issue deals. Within any particular vintage there is room for more pricing differentiation, especially if underwriting standards loosen and leverage points continue to increase. Lisa Pendergast: I may sound like Pollyanna here, but I’m going to say it anyway. I have some confidence that this time around will be better. The rating agencies have been put under such a microscope and I’m hopeful they’ll be guided by that and not by the fact that increased competition within the rating agency universe means there is less to go around. To the good, credit CRE Finance World Autumn 2013 16 enhancement has increased along with the percentage of IO loans and deterioration in stressed rating-agency LTVs and DSCRs in 2013. I’m not sure that is going to prevent us from getting to Larry’s ninth inning, but I think it will slow that process. And, while there may be something to hate in the risk retention rules for everyone, they too will slow the market’s natural inclination to race to the cliff. Samir, I think the rating agencies have stepped up their game in the 2.0/3.0 CMBS environment. Yet, there have been almost no structural changes in the way in which the agencies operate. Does that concern you as an investor? Are you comfortable with what you see from them thus far? Samir Lakhani: We have seen some of the enhancement numbers go up in light of the higher LTVs, and that’s a positive. But, for us, it really comes down to collateral underwriting. Ratings are important for capacity and liquidity in the overall financial system as there are still a number of ratings-constrained buyers. But, if you look at the legacy market as an example of deals moving through time, there is a wide variance in ratings on any one security. Some securities have an investment-grade rating from one agency and a below investment-grade from another agency. So it’s another set of views on the collateral that we take into account, but we predominantly rely on our own credit work. Lisa Pendergast: What can a lender do with a loan structurally to protect against bad-borrower behavior? Mitch Resnick: You can try to structure around it as much as you want but there will still be risk. There are mechanisms you can use to try and set at-risk borrowers off to the side, springing recourse is one method we saw pre-crisis and I think what happened during the crisis proved that mechanism doesn’t necessarily work. While it sounds great on the surface, it’s kind of like the nuclear option; you never think you’re going to have to use it. It hasn’t prevented folks from filing for that bankruptcy to try to protect themselves. Like I said, you can try to wall them off as much as you can but it’s never going to be 100%. Lisa Pendergast: Sam, in terms of the property market themselves, where are we in the cycle? Sam Chandan: In terms of the underlying fundamentals for the properties, the trends have been in line with what we have been observing in the broader economy. There are certainly some sub-types and geographies that have done better or worse in terms of recovering their fundamentals. With the exception of the CRE Finance World Roundtable: Macro Issues Facing CRE Finance “It seems like there are some shops that are a little bit “risk-on” that I wouldn’t have necessarily have expected... but it’s not at that stage now where I’m shaking my head because people are doing stupid things from an underwriting standpoint.”


CRE Finance World, Autumn 2013
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