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CRE Finance World, Summer 2013

Paul Fiorilla: Is it the same calculation if you’re buying BBBs? As Sam mentioned, BBB spreads have gone from 900 to 300. No doubt the dynamics are not exactly the same, but surely BBBs are subject to a lot of credit loss calculations, just like B-pieces. So that’s quite a dramatic change in price in one but not the other. Sam Chang: If you look at recent issuance, I don’t think the credit quality is bad. However, the rally in BBBs over the same time period implies that the credit got better, which I disagree with. I think the credit quality in the market has gotten worse over the last few years. But the way B-piece trade is far less technical than the bonds at the top of the capital stack, which is why I think it is not moving in lock step. Frank Scavone: I agree with that. I don’t think that trading ranges on the BBB position have much to do with credit; it’s really competition for yield. We own BBBs. We typically don’t go into that position. The only reason we ever did was because it made sense to buy up in the capital stack at that particular point in time. Paul Fiorilla: I’ve heard talk that some of the new players in highyield debt, including CMBS B-piece and mezzanine loan buyers, are financial buyers. In other words, they are buying for the higher yield and not adequately underwriting or understanding the credit risk. How is that an issue for the rest of the market? Sam Chang: Yes, I do have concerns. With more investors competing for the same set of investments, you’ll have some buyers, whether new or existing, who feel compelled to accept weak loans to win deals. This will also encourage issuers to originate similarly weak loans that had not been previously accepted in the B-piece buyer community thereby lowering the market standard for loan quality. This lowering of credit standards doesn’t have to be for the entire pool. All you need to do is lower the credit quality of the worst 5 or 10%, and that’s going to dramatically lower the investment quality for the B-piece. Paul Fiorilla: Jon or Lainie, do you ever consider starting to originate higher-LTV loans because there is someone willing to buy them? Or do you see that anywhere else in the market? Lainie Kaye: Many members of our credit department have been here 15 to 20 plus years; we’re not pulling new tricks on older dogs here. The fact is there are far fewer loans in these pools. It’s not like in 1.0 where we were doing 200 plus loans in a securitization. There is more due-diligence on the B-piece side and on the mezzanine bonds than was ever done before, because they can do it with fewer loans. So one shop can easily do 60 and on the high CRE Finance World Summer 2013 12 side maybe 100 loans on these deals. From that perspective, it gives the B-buyers a lot more time to go in-depth on each loan. I think this fact is attracting new buyers. They are not necessarily looking at 200 assets and some of the B-buyers don’t have the capacity to look at that amount of loans anyway. From that perspective, we see that there is even more of a microscope. It’s a smaller amount of loans and each one is looked at more thoroughly than ever before both internally and from the buying community. Jon Strain: The jury is out. We haven’t seen a lot of new accounts buying yet and none of them are telling us they want to compete by taking on higher LTV loans. The term “financial buyer” is used to diminish their investment prowess relative to a credit buyer. A lot of these guys are building sophisticated computer and surveillance models to track hundreds of loans in the 1.0 deals, and we may not be giving them credit that they are actually doing the work. The internet alone can allow you to find more stuff than any 1.0 investor could get without an extraordinary amount of time and investment. The firms with 1.0 portfolios have a tremendous amount of information about the performance of certain loans and markets and it can be a plus or a minus. It can be baggage — they don’t want to buy that loan because they’ve bought the one down the street and had a bad experience. Or it can allow them to accept a risk they have seen perform well over time. They’ve got so much information in the existing portfolio that they can be more biased or more comfortable with an asset. They also carry the baggage with the decisions they made in working out 1.0 deals. Anyone with a big 1.0 special servicing book has had to go on the tour convincing people that workout process was done to the benefit of senior bondholders as well as B-piece investors. Not everyone has been as successful in portraying how 1.0 experience is beneficial in 2.0. Frank Scavone: That’s a very good point. It doesn’t really matter how people get to the right decision. Sam’s group is out there, raising money in many instances from the exact same people that we are. We are sometimes directly competing for the same allocations. Since 2009, raising capital has been an incredibly difficult process from guys who have; A) been burnt in the past by structured finance products or B) to date have only dwelled in the equity investment world. At all of these conferences, I’m amazed at how close the pension fund community is. These CIOs all talk to each other. They talk. So if Sam’s investor at a pension fund loses his investment early on, then that creates an inability for the rest of us to raise capital on a predictable continuum, which obviously means we fail to deliver this essential portion of the capital stack. CRE Finance World Roundtable: The B-piece Buyer


CRE Finance World, Summer 2013
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