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CRE Finance World, Winter 2014

A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 19 are very very low. It’s just not what they do. The banks would not make 10 year fixed-rate loans if we could not securitize them. Life insurance companies and pension funds historically provided that debt, but their capacity didn’t match the opportunity and thus this opportunity presented itself to securitize them. I think banks will definitely sell the risk to the B-piece buyers at wider spreads rather than retain the longer duration assets. But what Randy and his B-piece peer group does, is they have a product expertise, and they are generally investing on behalf of third part investors who have pooled their money together. What it will force is those companies will raise capital that has a different risk and yield profile and it may take a while for it to transform. Randy Wolpert: The problem is, it is not even clear that the capital exists right now. You’re not going to really know until you go out and try to find it because it has never needed to be there. Jon Strain: Worst case, let’s say you are buying a B-piece of 5% at 50 cents to the dollar, so the math is easy. So for every billion dollars you put into $25 million to work. If you have to buy the next 5% as well, today it doesn’t sell at the same dollar price. Now you have to take second loss 5% and take something like a 50% discount on that, you can do that math and you lose 2.5 points on a the sale. On a pool of 10-year loans, the value of that is about 30 to 50 BPS. So if we sold Randy the same first loss investment but now twice as big, that would be a safer investment for Randy, but he would have to raise twice as much capital. But if you have twice as much assets under management for the same cost of deployment, that is really good situation for you. I think it will normalize at less than that scenario, so the ultimate cost to the borrower is less than that. On the margin, it is not great to have CMBS to be less competitive, but I don’t think it is a death knell. Brian Lancaster: Given that this will go into effect in two years from the time is finalized presumably in the next month or couple of months, do you think the market will begin to adjust their business model prior to that? Will people start moving or pricing these changes in 2014 well before the end of 2015 early 2016? Randy Wolpert: It is a huge issue because there is not going to be any clarity. Who is going to decide to move first and what will everyone tell their investors? It is not easy now to raise this money and the business is relatively easy to define because it has been around for a long time. Now you’re going to have a fundamental change. No one is going to know that what the investments are going to look like, so you’re not even sure the returns to project. The rules might look different but whatever they look like, there is going to be a tremendous amount of uncertainty until some deals get done. It could be an opportunity but it could also be complete gridlock. I would expect that the banks are going to have to sit back at some point and say, I have to be careful on what kind of loans I am going to make if I don’t think I can securitize them by the time these rules go into effect. That has got to be difficult. Jon Strain: We are in our own little CMBS world, and we have greater communication amongst all the parties and I think we will be able to figure it out much faster than we are describing here. For the investment banks and securitizers, the residential market is way more complicated. The residential market still hasn’t turned the corner; they don’t have freedom from regulatory constraints. The rating agencies still are more defensive, and they don’t have a B-piece exemption, so I think the banks are going to be much more focused on how they address securitizing of residential mortgage loans and how they fix that. I think this will be a very small component of it. The people who figure it out first will probably make some outsize profits briefly. This doesn’t scare me that much. Maybe I’m naïve, but I believe that we will be able to figure it out because we do have such a long implementation period. Brian Lancaster: Richard, would there be an opportunity for insurance companies, given you are natural holders of the 10-year position? Richard Walsh: It has been done before primarily through fund structures, where insurance companies provided the capital to invest in B-pieces. I’m not sure that buying B-pieces directly is a good product for us, given the level of due diligence that we like to do on assets, but there could be other life companies that look at it differently. Brian Lancaster: Right, given now that there is this long-tailed piece of paper out there, someone’s got to hold that now. Jon Strain: I don’t see that as a life co opportunity. Most of these loans are loans that the life companies could have done themselves directly if they really liked them. Insurance companies participate in the investment grade portions of CMBS, but it is the rare insurance company these days this is buying below investment grade securities of any kind due to NAIC capital rules. Brian Lancaster: Let’s talk about servicing. Dan, we’ve seen loan modification activity come down significantly with the improvement in the liquidity of the market. Do you think loan modification activity will continue to abate in 2014? Dan Bober: Absolutely. I think for loan mod activity and virtually all special servicing activity as you go into 2014, all of the positive trends that got us through this year — improved real estate fundamentals, CRE Finance World Roundtable Discussion: 2014 Outlook


CRE Finance World, Winter 2014
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