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CRE Finance World, Summer 2013

the collateral for what it is, not because someone needs to hold it by law. Frank Scavone: Isn’t the rule kind of misaimed? Shouldn’t the rule be designed to govern the behavior of the person making the first decision in the string of decisions, that being the lender? Paul Fiorilla: I think the issue is that somebody has to have the responsibility for that credit. The B-piece buyers did a great job of that through much of the market’s history. But when B-piece buyers started to resecuritize their holdings, and no one in particular was focused on the risk, that’s when the market lost track of loan quality. Then we had the crash, not that it was the only factor, but certainly it was one of the most important factors. Frank Scavone: In that second instance, I agree the risk should lie with the B-piece owner, the original aggregator of the high yield investments that are resecuritized. I totally agree with that. But in context of the first stage here, does our willingness to take risk, impact the behavior of Jon or Lainie beyond… “I hope I can sell this loan.” Isn’t that essentially right? Jon Strain: Yes, well, the one thing that securitization does is it increases the capacity of the market for people who can’t or don’t have the capacity to originate. And so, all these bonds that we are creating and selling to the largest money managers, banks, and hedge funds, someone needs to manufacture all of that. Would I do my business differently on the margin if I could only originate $1 billion a year and had to keep it? I think I probably would. But then, you would have to do so many fewer loans that by nature, you’d be selective. If each of you could only buy one B-piece a year, you wouldn’t buy the first one that you saw. It’s sort of an unusual construct, risk retention with the B-piece investor buying the risk. Lainie and I have to originate loans understanding that we have to sell them. In some ways, I feel like I have to make a loan that is attractive enough that I can find someone else to buy it. Frank Scavone: That is the impact on behavior that I was pointing to. I agree with you one hundred percent. And I also agree with the value that you bring to the market in using your balance sheet to aggregate loans in billion dollar increments. I understand that there has to be some manufacturing facility so that the people who are buyers of different segments of the capital stack can actually do that. We don’t have a billion and a half dollars to aggregate loans and then sell off the parts that we don’t want. So, you are providing a service. Perhaps that’s exactly why the rules are designed to CRE Finance World Summer 2013 16 recognize that service and not put you in the position where, in 5% increments, you ultimately run out of balance sheet to perform it. Lainie Kaye: It’s not just a service, it’s also an expertise. We are manufacturing but we are also structuring, as well as providing underwriting, and other components to a loan that others don’t have the capacity to do. People look to a few of us because we know what to look for and what to structure around if an issue comes up. It’s just not a commodity like that. Frank Scavone: I agree with that. Like I said, certain lenders are better than others. It’s all about structuring around credit risk. But your ability to dedicate a portion of your balance sheet is unique. It is a necessary part of the infrastructure required to deliver capital into the commercial real estate finance market. Without you guys stepping up to take the risk of aggregation, there is no market and we all have the CMBS issuance graphs to prove it. Paul Fiorilla: Re-Remics are starting to creep back. Are we anywhere close to seeing a resecuritization of subordinate CMBS? Jon Strain: I don’t know that the market is quite ready for that. Proposed Dodd-Frank rules prohibit the financing of retained risk which will make it even more unlikely I think a lot of people saw that the B-piece CDO was one of the top tic signs of 1.0. We have seen some re-remics of multi-family CMBS deals that were previously unrated, but not really a B-piece CDO as much as a repackaging that is tranching previously un-tranched product. Paul Fiorilla: All loans written today have historically low coupons, thanks to the low interest-rate environment. How do B-piece buyers account for that, since it seems almost certain that the loans they are buying today will be refinanced in a higher interest-rate environment? How does this affect credit and how do you underwrite for that? Matt Salem: All the things being equal, it pushes losses back. You have debt service payments on the lower coupon so it could actually push back a default given its easier to cover the debt service with property cash flows. We all think a lot about debt yield. We clearly think about refinance risk and where normalized cap rates will be and where the 10-year note will be when these loans come due. A lot of what we solve for is debt yield. We ask ourselves what is the stabilized debt yield of the asset and how does that look in a normalized refinancing environment? CRE Finance World Roundtable: The B-piece Buyer


CRE Finance World, Summer 2013
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