Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

Here is an up-date from the CREF-C on the joint committee charged with reconciling the House and the Senate financial reform bills.

The summary focuses on three topics:

• risk retention in CMBS deals
• FAS rules 166 and 167
• covered bonds

The CREF-C up-date:

To begin, House Chairman Barney Frank (D-Mass.) presented a "House offer" that would significantly alter the risk "retention" provision, including language in both the House and Senate-passed bills that recognizes the unique nature of the commercial mortgage market.

Senate Chairman Chris Dodd (D-Conn.) counter-offered by accepting most all of the House offer, but Senate conferees explicitly rejected the House request to strike Senate-passed amendments offered by Sen. Mike Crapo (R-Idaho) related to "commercial mortgages" and by Sen. Mary Landrieu (D-La.) to create a "qualified mortgage" exemption. The risk retention provision remains outstanding, as negotiators try to break the stalemate and reach agreement on the final provision.

Separately, the Conference Committee adopted an amendment offered by Rep. Scott Garrett (R-N.J.) that would require financial regulators to examine and report on the combined impact of new accounting standards (FAS 166 and 167) and other regulatory changes (such as a "retention" mandate) on credit availability, prior to any rulemaking. Under the provision, the Federal Reserve (working with other agencies) would have 90 days to report its findings to Congress with recommendations on statutory and regulatory changes that could be made to lessen the impact on credit availability.

Lastly, House conferees passed another amendment by Rep. Garrett that would provide a statutory framework to facilitate a U.S. covered bond market, which explicitly includes commercial mortgages and CMBS as forms of eligible collateral. The "House offer" on covered bonds – which is supported by Sen. Bob Corker (R-Tenn.) – is now being considered by Senate conferees, as well as financial regulators (Treasury, FDIC, and others) that have raised questions about its execution.

The Conference Committee meets this afternoon to consider these and other items. Conferees hope to conclude their work to reconcile the two bills this week, at which time any Conference report would need final approval by the House and Senate.

 Stay tuned.

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The tentative time line for the House-Senate reconciliation conference committee covering the financial regulatory reform legislation is the following: begin to meet during the week of June 7, 2010, with the goal of having a final Bill ready for the President’s signature by the July 4 recess.

With that quick time line in mind, here is a quick up-date on:

• High-level comparisons of the House Bill and the Senate Bill
• The membership of the House-Senate Reconciliation reconciliation conference committee
• Last hope for inclusion of covered bonds in the final bill

Comparisons of the House Bill and the Senate Bill:
As you know, the two bills are very, very long.  And I'm sure that some where in DC, Congressional staffers are preparing a detailed comparison of the two bills (as part of the reconciliation process). So, we'll have that good comparison shortly.  In the interim, here are high-level comparisons by the Associated Press and by PBS.

Membership on the Reconciliation Conference Committee:
Here is the list of the Senators on the conference committee (8 Democrats and 5 Republicans; eight members of the Banking Committee and five from the Agriculture Committee):

• Tim Johnson (D-SD)
• Jack Reed (D-RI)
• Chuck Schumer (D-NY)
• Chris Dodd (D-CT)
• Blanche Lincoln (D-AR)
• Tom Harkin (D-VT)
• Pat Leahy (D-VT)
• Dick Shelby (R-AL)
• Bob Corker (R-TN)
• Michael Crapo (R-ID)
• Judd Gregg (R-NH)
• Saxby Chambliss (R-GA)

And here is the list of 8 Democratic Representatives proposed for inclusion on the committee by Representative Barney Frank (D-MA) (I have not seen a list of the 5 Republicans to be named by him):

• Barney Frank (D-MA)
• Carolyn Maloney (D-NY)
• Paul Kanjorski (D-PA)
• Luis Gutierrez (D-IL)
• Maxine Waters (D-CA)
• Melvin Watt (D-NC)
• Gregory Meeks (D-NY)
• Dennis Moore (D-KS)

No doubt, this list will be finalized in the next week.

Final Hope For Covered Bonds: As noted by the Covered Bond Investor and by CNBC, the U.S. Covered Bonds Act (introduced in the House by Scott Garrett [R-NJ] and co-sponsored by Spencer Bachus [R-Ala.] and Paul Kanjorski [D-Pa.]) did NOT make it into the financial reform bills passed by either the House or the Senate.

Both of these blogs note that the following is the only hope for covered bonds becoming part of the final financial reform bill:

• The appointment of Representative Garrett, Bachus and\or Kanjorski onto the House-Senate conference committee
• And then their ability to convince the committee to add the covered bond bill into the compromise bill adopted by the committee

So, with Representative Dodd's appointment of Representative Kanjorski to the committee, covered bonds still might be part of a solution to the credit crisis, and a viable product in the U.S.— if he can convince the committee to add covered bonds into the final bill.

As I've noted before, my perspective is that covered bonds need to be included in the financial reform bill—simply because the new CMBS 2.0 will not be sufficient to meet the credit needs of the commercial real estate finance industry.

If you see it differently or have additional information, please post a comment below.
 

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James Ruiz recently wrote a piece, published in the Texas Lawyer, summarizing the February 10, 2010 report (“Commercial Real Estate Loses and the Risk to Financial Stability”) issued by the Congressional Oversight Panel. (continue reading link below). It is a good summary of the Panel’s perspective of the credit problems in commercial real estate, and addresses the REMIC issues inherent in modifications of CMBS loans and the impact of two new accounting standards (Statement of Financial Standards 166 & 167).

Earlier, I posted a summary of the report, and commented that if financial reform is going to occur, the window is narrow given the August start of the mid-term Congressional re-election campaign season. As you might know, I’have been blogging\following the Restoring American Financial Stability Act of 2010 [link] as it makes its way through the Congressional process. 

It’s time to step back and ask the all-important questions: so what does all this mean? What is the big-picture? Where is this going?

Here’s my list of some of the answers to those important questions:

1. The Good: ‘Return’ of the unregulated CRE lenderr. in the near future, unregulated lenders will play a very important role in CRE finance. This will mean new opportunity from a new source.
2. The Bad: ‘Extend and Pretend’ and More Defaults. This will mean continuing opportunity for special servicing and asset management - but the RTC is not the model.
3. The Uncertain CMBS 2.0: Practical and important structural challenges abound before the new CMBS (“CMBS 2.0”) will include pools of loans from multiple borrowers, in amounts that will have a meaningful impact on the CRE finance market.
4. The Not Now For Covered Bonds: the current focus is on CMBS 2.0, although covered bond legislation was introduced by members of the House Financial Services Committee – Capital Markets Subcommittee. Why isn't’t this legislation getting more attention?

Based on this list, the next 2-4 years will look like this: CRE finance = Good+Bad.

Yes, we’ll have good and bad at the same time (with more of the later in the near-term).

Let me briefly explain:

#1. “Unregulated Lenders” Will Play An Important Role In CRE Financee: By this phrase, I mean lenders who are not banks, savings and loans, credit unions, insurance companies or government sponsored entities (such as Fannie Mae). In addition, these lenders will be different from “hard money” or “hot money” commercial lenders, who as lenders of last resort offer loan terms that resemble predatory lending.

Instead, these lenders will be mortgage REITS and other lenders whose base or core sources of funds are not the Federal Reserve, insurance premiums or Federal Government sponsorship (which I call the “traditional sources of CRE finance”). The pricing and terms will be more favorable to the borrower than offered by the "hard money" or "hot money" lenders, and more expensive than terms than offered by traditional sources of CRE finance. In my description of this middle-tier CRE finance group, I’m thinking of mortgage REITs such as CreXus and of mortgage finance companies like the former Lomas & Nettleton.

What leads me to this conclusion?

• One study reports that traditional sources of CRE finance only offer @ $200Bill of funds annually for CRE lending (based upon a recent three year average of loan originations by this group).
• The same study shows that CRE lending needs for maturing debt will exceed this amount by a total of $500Bill in 2010, 2011 & 2012.
• This “funding gap” doesn't’t take into account funding for defaulted CRE loans (by way of financing purchases of notes and REO from lenders and servicers). So, the gap really is larger than $500Bill
  
  What will be the source of funding to “fill” this gap?
   
• CMBS 2.0 will not fill this funding gap any time soon. True, banks and life companies are forming CMBS 2.0 programs – and we’re working on several of them. However, at the CMSA January conference, in an informal poll of investors, 58% of the investors believed that “CMBS 1.0” style multi-borrower, fixed rate pools will be return no sooner than 2012 (or even later); and 69% of the investors believed that annual new CMBS issuances would not exceed $100bill until 2013. (click on this link to my blogs from the conference for more information; and\or search TTFL blog using the term “CMSA” for more information.)  The message is simple: CMBS 2.0 probably is not a near term reality for multi-borrower loan pools in an amount necessary to close this gap  – which also is why the new CMBS 2.0 programs will be underwriting loans as if they were going to hold them on their books – and not sell them in a securitization.
• Bank CRE lending will not fill the gap for several reasons:
  -  Banks credit allocations for CRE will decrease for the near term (my guess: 3-5 years). Recently, the US Controller of the Currency spoke at the annual convention of the Independent Community Bankers of America, and called on policymakers to devote special attention to the CRE lending concentrations at banks. He then suggested a lengthy list of options, all of which would reduce lending risks AND result in less capital available for CRE lending.  Regional and community banks have high CRE loan concentrations.  For example, I've been told that the CRE lending concentration for banks governed by the Dallas Federal Reserve Bank is @ 26%. Simply too, too much CRE loans on the bank portfolios.
  -  The Wall Street Journal reported on March 15Th that in the coming weeks, the Financial Accounting Standards Board is likely to propose that banks expand their use of market values for financial assets such as loans (called “mark-to-market”). If these accounting rules are implemented, then this will be another pressure on banks to make less capital available for CRE lending.
• Insurance company CRE lending will not fill the gap. Recently the Capital Adequacy Working Group of the National Association of Insurance Commissioners (“NAIC") voted to release for comment a proposal that might result in a large increase to the risk-based capital (“RBC”) charges for life company holdings of CRE mortgages.   If passed, this could significantly restrict the ability of some life companies to make capital available for CRE lending.

All of this points to opportunity for a new niche CRE lender.

#2. Extend and Pretend AND More Defaults:  as noted in our postings on the October 31, 2009 bank regulatory announcement, and at the CMSA January conference, the regulatory plan clearly is to avoid taking back CRE collateral if it has some reasonable basis for keeping the loan current. Many people, myself included, called for a quick RTC style take over of failed banks, with a quick disposition of the assets. Clearly, absent a change in the mark-to-market rules (described above), the perspective of the administration is that the current CRE crisis is NOT attributable to over building. Instead, it is a credit crisis unrelated to CRE. So, the plan seems to be extend until the fundamentals for the broader economic recovery firm up as evidenced by: increases in employment; improvement in consumer confidence and spending; etc.  In other words, treat the source of the problem, and not the symptoms.

However, default rates on CRE mortgages continue to climb (see my earlier posting).

So, unless and until we clear much of the over-leveraged CRE from the market (my “sub-prime commercial” product type), if you have expertise in distressed CRE, then you should be busy.

And, if your company can handle both the good AND the bad, then you’ll really be busy.

In the near future, I’ll cover #3 and #4.

If you have any questions, comments or suggestions, please post your comments below.

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Once again [link to earlier letter], in a letter dated March 25, 2010, the 21 key industry groups band together in an attempt to focus the Senate on the importance of the securitization market, and to caution the Senate on the proposed reforms relating to the securitization market. The players in this group represent an extremely broad segment of the US economy:

• American Bankers Association
• American Hotel & Lodging Association
• American Resort Development Association
• American Securitization Forum
• Associated General Contractors of America
• Building Owners and Managers Association International
• Certified Commercial Investment Member Institute (CCIM Institute)
• Commercial Real Estate Finance Council (formerly CMSA)
• Community Mortgage Banking Project
• Institute of Real Estate Management
• International Council of Shopping Centers
• Loan Syndications and Trading Association
• Mortgage Bankers Association
• NAIOP, Commercial Real Estate Development Association
• National Apartment Association
• National Association of Real Estate Investment Trusts
• National Association of Real Estate Investment Managers
• National Association of Home Builders
• National Multi Housing Council
• The Real Estate Roundtable
• Securities Industry and Financial Markets Association

The challenge is to keep the message, and the Senate’s focus, simple despite the expansive scope and length of the “Restoring American Financial Stability Act of 2010”  – yet financial reform is a topic that invites amendments. (Recall the 473 amendments made on the bill in the Senate Banking Committee.)

The letter [download] addresses the importance of the securitization market as a key source of liquidity for economic recovery. The message is very simple and pointed:

• credit markets are constrained despite enormous demand for credit and significant loan maturities – all in the face of declining values
• new accounting changes will limit balance sheet capacity and the overall amount of credit
•  the bill’s proposed “risk retention” terms will further limit balance sheet capacity and lending capacity

The letter states that “given the totality and far reaching implications of regulatory and accounting changes, there are serious concerns about the future viability of the securitization markets that are critical to borrower access to credit and an overall recovery.”

Perhaps because the letter is from a broad segment of the US economy, it does NOT address several important topics of importance to commercial real estate, such as -

• Covered bonds: note that on March 18, the House Financial Services Committee – Capital Markets Subcommittee (ranking members are Scott Garrett, R-NJ, Chairman Paul Kanjorski, D-PA, and Spencer Bachus, R-AL) introduced covered bond legislation. I’ll address this important bill in a future blog posting (For background on covered bonds: link)
• Rating agency reform: clearly this is a topic of key importance for securitizations involving commercial real estate (i.e., CMBS).

Regardless, it is good to see a broad spectrum of key industry groups join together is support of a specific, and focused, aspect of the reform legislation.  The collective strength will be needed.  It will be an up-hill battle.

If you have thoughts or comments, please post them below.

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As I noted previously [link], the mid-term elections significantly limit the time period for Congress to pass a meaningful financial reform bill. The “window” for this closes in August – five months from now – when the fall election campaigns kick into high gear.

With this short-course in mind, the CMSA and other key industry groups (listed below) are peppering Congress with this message: restoring lending for commercial real estate, and the capital markets supporting this lending, are critical elements for the nation’s recovery from this great “recession.” AND action needs to be taken now.

Here are three examples (with a few comments by me) of action taken over a recent Thursday through Monday:

1. Thursday, Feb. 25 Letter: The organizations include those listed in a letter [download\link] sent on Thursday (Feb. 25) to Committee Chairman Chris Dodd and Ranking Member Richard Selby of the Senate Banking Committee. It is an impressive list:

American Hotel & Lodging Association

American Land Title Association

American Resort Development Association

Associated General Contractors of America

Building Owners and Managers Association International

CCIM Institute

Commercial Mortgage Securities Association

Institute of Real Estate Management

International Council of Shopping Centers

NAIOP, Commercial Real Estate Development Association

National Apartment Association

National Association of REALTORS®

National Association of Real Estate Investment Managers
National Multi Housing Council

Briefly, this letter argues that the “risk retention” requirements (also known as “skin in the game”) for CMBS 2.0 issuances need to allow a third party (known as the “B-piece” buyer) to hold that risk. 

Comment: one lesson learned from CMBS 1.0 that this third party will undergo greater financial scrutiny and underwriting by the initial investors, AND by potential buyers in the secondary trading market. And, I believe, investors will look for ways both to monitor the “skin in the game” party and to receiver better loan level information if\when a workout or default arises under a specific loan. Underwrite this third party? Sure. Better information from this third party? Bet on it.

2. Joint Panel Hearing on Friday, Feb. 26: The House Financial Services Committee (chaired by Barney Frank, D-Mass) and the House Small Business Committee (chaired by Nydia Velazquez, D-NY) held a hearing to discuss commercial real estate and issues facing small businesses.

Questions:

• How many people attended this hearing? (Hopefully more people than the handful who attended the Dec. 15 hearing on covered bonds.) [link to my two postings on that meeting]
•  What kind of media coverage did the Feb. 26 hearing generate? Was it “lost” in the health care debate and other issues?

3. Monday, March 1 position paper: The CMSA issued a paper titled “A Framework for a Sustainable Commercial Real Estate Recovery” [download\link]. This is a must read. The paper gives a succinct description of the current state of the CRE market, a listing of “unique” features of the CMBS product and market, and a framework for CRE recovery.

A few comments:

• There is no mention of CDOs [link] – thankfully.
• The paper states that one unique feature of CMBS is “most CBMS loans have 5- to10- year terms with 20- to 30-year amortization schedules.” Question: no mention of all of the interest only (“IO”) loans? What percentage of the loans currently in special servicing loans are IO loans? When people discuss implementing “standard underwriting” standards, are they really talking about banning IO loans?
• The paper states that the structure of CMBS allows investors the ability to gather detailed, loan level information; and that the information available to investors is “tremendous.” While this is the message in the front entry hall, the pillow talk in the bedroom between investors and special servicers is all about the need for MORE loan level information.  Greater loan level transparency is a late night topic certain to bubble up in the CMSA's new Investor Forum.
• The paper points to a recent European ruling that requires credit agencies to implement new ratings for certain US securitized products. Putting aside the merits of the argument, it is alarming that the investment community appears at odds with industry organizations on this basic issue – or at least the EU sees it differently. Can this get any more complicated? (Remember: the window slams shut in August.)
• Finally, I’m pleased to read that covered bonds remain on the list. Covered bonds [link] are a favorite topic of mine - as the best, long-term capital market product for commercial real estate.

If you have any questions or comments, or some observations of your own, please post a comment.

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 One take-away for me from the second day of the convention is this: while the three different perspectives (below) point to 2010 being a better or different year than 2009, it will be far from “normal” (when compared to 1994-2004).

The Mortgage Banker: relieved

The general sense or mood of the mortgage bankers is that 2010 will be much, much, better than the train wreck of 2009 – a year of almost no new financings closed. Finally, some mortgage production. And a sense that “we made it.” And thankful for the possibility of having some meaningful work.

The Life Company Lender: guarded

On the other hand, the message from the life company lenders is that since corporate spreads are so low (when compared to the spreads of a year ago), they will be lending this year.  Their target, however, is the best borrowers and on the best property (with great DSC, LTV, etc.). And they admit that some percentage of their 2010 loan origination will be devoted to refinancing (extending) loans currently in their portfolio.

The MBA Staffer: focused on the Hill

The MBA is focused on better serving its members, as evidenced by a reorganization of its committees into various “councils” centered on its membership. But more importantly, it is focused on the US Congress and the Obama Administration.

It seems that the discussion in almost every panel returns to public policy, or financial reform.

Take a look at the MBA’s 2010 public policy priorities:

• Financial crisis responsibility fee
• Risk retention (“CMBS 2.0”)
• REMIC rule reform (“CMBS 2.0”)
• Rating agency reform (“CMBS 2.0”)
• Risk-based capital for CMBS under FAS 166 & 167 ("CMBS 2.0")
• TALF CMBS extension
• FDIC legacy loan program
• GSE restructuring (the “new” Freddie & Fannie Mae)
• FHA modernization
• FHA multi-family loan limits
• Low Income Housing Tax Credit
• Funding for rental assistance
• Life Insurance Company risk-based capital
• Covered Bonds
• Carried interest

NOT a short list!

The “real” focus on the MBA is as it should be – on the Hill. Unfortunately, the mid-term Congressional elections effectively will inhibit the passage of new legislation starting this August. So, the window for addressing these priorities is quickly closing.

The next time you hear the phrase “financial reform,” think of this long list – and the August finish line.

My Bottom Line: low expectations

No doubt, a lasting recovery for the credit market will hinge on jobs and consumer confidence.

However, just looking at the long, long, long list of public policy priorities tells me that we are a couple of years away from returning to the new “normal” – effectuating changes like this will take time. My prediction is that only a few items on this list will be realized in 2010.

Seriously, does that look like a “quick fix” list to you?

If you have any questions or comments, or your own perspective, please post a comment.

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Commentators note that one great attribute of the Internet, and the communities formed within and around it, is this: when someone wanders off (or climbs on a ledge), the community does a good job of nudging each other back to the group.

Yes, I was a little disappointed (OK, even upset) at the lack of focus by the CMSA on covered bonds at the January conference (see my comment regarding the session called "Lessons From CMBS 1.0").

However, my friends at the Covered Bond Investor (link) correctly note that the Mortgage Bankers Association lists covered bonds as part of "legislation among the organization's legislative and regulatory priorities for 2010."  (posting on the MBA list)

My sense, however, is that covered bonds will NOT be a near-term reality. 

But thank you, Covered Bond Investor, for talking me off the ledge.

If you have an interest in covered bonds, visit the Covered Bond Investor.

And if you have any questions or comments for me, please post them below. 

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As noted in my lengthy postings summarizing the recent 2010 CMSA January Conference in DC [Day 1 link; Day 2 link], over 1,000 commercial real estate professionals attended the conference – roughly 2X more than expected.

Why this unexpected attendance? Answer: All of us are looking for answers amidst the continuing liquidity problems in the CRE Capital Markets. This topic was the sole focus at this conference.  (And it even shows in the number of people "visiting" TTL blog since the Tuesday [Day 1] posting: we show over 1,000 total "hits", of which over 550 are "unique", as of this blog posting.)

 I've received feedback asking for a summary covering a specified set of topics from the two (much, much longer) blogs covering days 1 and 2.  (Keep that feedback coming!)

So, here is that subset of information from the 2010 CMSA January Conference:

INVESTORS FORUM

This forum is for a broad band of CRE debt investors (such as B note holders, mezzanine lenders).

The meeting time was devoted to a survey of the 250+ people in the room. Here are some of the responses: 

• 45% of the voters believe that CRE values will continue to fall in 2010 with no recovery in CRE values until 2011 (this fall is in addition to the 44% fall from 2007 CRE pricing)
• with respect to the 2005-2008 CMBS pools, 37% of the voters believe that the average losses will be in the 11%-15% range (these loses will wipe out bond holder through the "AJ" class)
• 43% of the voters believe that for CMBS loans liquidated in 2010, the average loss severity will be 40%-50% (and 27% believe that the average loss severity will be 50%-60%)
• 69% of the voters believe that annual new CMBS issuances will not exceed $100B until 2013
• for new CMBS issuances in 2010: 50% of the voters believe that issuances will be single borrower transactions; and 33% of the voters believe that issuances will be multi-borrower and large loan structures (with only a few assets); and
• 58% of the voters believe that "old-school" multi-borrower, fixed rate deals will return no sooner than 2012 (or later)

REAL ESTATE FUNDAMENTALS: "THE FACTS OF LIFE"

If the focus on "CMBS 2.0" (which is the "hot" phrase used to describe the "new" CMBS model and market) is a bit too out of touch for me, this session just hammered on the current picture of the CRE market:

• unemployment at historical highs (and still rising)
• retail sales still stumbling
• consumer confidence falling
• "asking" commercial rents falling
• commercial leasing activity (absorption) falling
• CRE sales activity: stagnant
• CRE values -43% from the high in 2007
• huge amount of CRE loan maturities over the next three years, with inadequate sources of credit to pay-off those maturities
• huge shortfall in CRE equity (such that it will not fill gap between the credit available and the looming CRE maturities)
• over 75 funds have been formed to buy distressed CRE debt and properties; but little it has been deployed
• very little CRE has been "re-priced" or "re-set" by lenders or servicers foreclosing or disposing of assets
• we're still early in the CRE recover (perhaps only 25% into the process!) (One interesting comment: remember that valuation adjustment occurs early in the CRE recovery process; so we might be 75%-90% into the valuation adjustment process.)
• importantly: no one on the panel, nor else where in the room, foresees an implementation by the Government of an "RTC style" approach (where the Federal government quickly closes large numbers of banks and thrifts, and then quickly sells the loans and assets at steep discounts – resulting in a "harsh pain" but quick re-pricing of CRE
• unlike the late 80s & early 90s: this time there is no new industry (such at technology) to lead the recovery by increasing employment

BORROWER PANEL: "SURVIVOR"

This panel focused on "how" a borrower could make it through until CRE liquidity returns.

The panel has some advice for borrowers:

• show up with $ if you want to restructure your debt
• if you're in a good city, with good tenants and with DSC (get it?
• Use $ to right-size the loan), then you'll probably survive

It was interesting that while reference was made to splitting up a CMBS loan into an A Note (with good DSC & LTV) and a B Note (representing the "bad" part of the original loan), no one gave any details on the structure (such as the terms of the B Note, the proceeds waterfall between the lender [under the B Note] and the "new" equity [that injected capital needed, in part, to right-size the Note A], the rate of return on the new equity, etc.)

SURVEILLANCE & WORKOUTS: "LET'S MAKE A DEAL'

This panel didn't give any real guidance on terms of workouts, other than to list some basic rules of the game:

Do This:

• be nice
• send all information in; be open and transparent
• sign a pre-negotiations agreement
• keep paying cash flow
• have a reasonable, cogent plan BEFORE you contact the lender or servicer

Do NOT Do This:

• tell lender or servicer that you're "partners"
• tell lender or servicer that you're a good borrower
• "fish" for information or for terms of a plan that will be acceptable
• cry
• hold lender or servicer hostage
• ask for any of the cash flow (nor a cash flow mortgage)
• fly in on a private jet
• offer a bribe
• rob Peter to pay Paul
• launch off on a religious sermon (caveat: "the special servicer knows that it is going to Hell – every day is Hell")
• ask for any return on the new equity infusion made in borrower

It was an interesting day. Much like our experience in Munich – very little clapping at the end of any session (yes, it reminded me a little of the sessions at the EU conference that we attended in October 2008) [link]

In a future posting, I'll cover comments made to us by several elected and appointed Federal officials.

If you have any questions, comments or observations, please post them below.

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(When we attend industry conferences, we bring you along by blogging on topics of interest to us, with our comments as a bonus. This is the second in a series of posting relating to, and from, the 2010 CMSA January Conference. [Link to Day 1] Our blogs on other conferences are found [i] under the "Market Trends" category in the archives on the right side of the page, or [ii] by a word or phrase search on the right side of the page [suggested search terms: looking glass; scorecard; pond].)

Technology Tip: darn, this American Airlines flight does NOT have GoGo Inflight Wi-Fi. I hate this. So, I'm forced to type this in Word, and then post it tomorrow morning from home. 

However, here's a tip on "how" I organize all of my passwords and PINs, including my password for GoGo:

- create a separate Contact card in Outlook for each website, frequent flyer\use membership, etc.; include the applicable website on the card

- be sure to password "protect" your phone\PDA (tip: use a password combination that you can enter with one hand, so that you can leave your other hand free)

Now, on to Day 2 . . .

Day 2 is the last day of the conference. It has a different feel than day one, in part because the crowd is significantly larger.

I've been told that when the CMSA planned this 2010 event, they anticipated @ 500 people would register for the conference. Whether is was the pain of an uneventful 2009 (read: no CRE money for no one), or simply wanting to be told that 2010 would be better (read: CRE money for someone . . . please), today it felt like every one of the registered 1,000 attendees crowded into the basement ballroom floor of the JW Marriott Hotel.

Yes, we're literally all "in this cramped CRE space together."

Today the program focused on different points of the CRE space, with appearances and comments by two members of the US House and by the Chairman of the FDIC. This posting will summarize the substantive items.

The comments by the elected and appointed officials will be included in a post later this week (or this weekend - I have to get caught up at "real" work).

Here are the highlights (with some commentary, of course) from the last session on Day 1 and several Sessions from Day 2.

LESSONS FROM CMBS 1.0: "THE WONDER YEARS"

Frankly, calling the "old" CMBS market\model "1.0" and then labeling the soon-to-come, "rejuvenated" CMBS market\model "2.0" strikes me as being very, very hopeful. From my perspective, CMBS 2.0 better be strikingly different and improved over CMBS 1.0. (Indeed, why are we so married to the CMBS model? As an Air Force brat, it strikes me as if we're focusing on making the bi-plane better.) And CMBS 2.0 better arrive quickly and with billions of Dollars. (Warning: 2.0 is no "CMBSuperman.")

Time will tell, of course.

But if the comments at this conference are correct:

• CMBS 2.0 will not arrive quickly
• 2.0 will not be the "proceeds party" that characterized CMBS 1.0, and
• 2.0 will not come close to bringing the liquidity needed to refi the huge amount of near-term loan maturities.

One panelist gave a very good description of the collateral damage to the CRE finance market caused by pushing CMBS 1.0 to the limits:

• Wall Street's intervention (or commodization) of CRE finance brought an incredible amount of liquidity to CRE
• Utilizing the CDO structure in the CRE space was a logical, yet terribly short-sighted mistake in that it effectively separated (or "de-linked" the unique credit risk inherent in CRE from the investment decision
• The liquidity party quickly spread across the CRE finance spectrum
• Wall Street underwriting, downward rate pressure, increase in proceeds and complicated credit "stack" structures quickly captured a significant share of credit extended to improved CRE, and in doing so, forced regional and community banks to change the focus of their CRE lending away from income producing CRE and into construction loans, builder lines of credit, land development loans and raw land loans.
• CMBS 1.0 was characterized by: (1) no future exposure by the loan originator and too many loan originators placed loans with other people's money (Comment: I call this the "merchant lender" mentality – 'if you lend it, someone will buy it'); (2) it did NOT adequately address the current "shut down" scenario (for example, the investment grade investor is given too little "control").
• Some of the lessons learned from CMBS 1.0, and perhaps early characteristics of CMBS 2.0:
  • the B-piece needs to be larger (for meaningful "skin in the game") or even structured out of the deal by having a mezzanine strips in place of a B-piece (the Inland Retail deal is an example of this);
  • the special servicer needs to be independent, or some other mechanism put in place to give the investment grade investor some assurance of impartiality by the special servicer, or the ability to have meaningful input on special servicer decisions;
  • limit the number of investment classes (for example, the DDR, Flagler & Inland Retail issuances in late '09 only have a handful of bond holder classes);
  • single purpose entity (SPE) changes in response to the GGP case; and
  • FINALLY, someone mentioned covered bonds [link to prior posting on covered bonds] – I find it very, very interesting that this comment was quickly brushed aside, as if the covered bond product was irrelevant. (So, if it is irrelevant, then "why" did a former President of the CMSA testify on the Hill in support of the product? Is the CMSA simply focusing on the near term revival of the CMBS market?  What about a long-term fix or better model?)

REAL ESTATE FUNDAMENTALS: "THE FACTS OF LIFE"

If the focus on 2.0 is a bit too out of touch for me, this session just hammered on the current picture of the CRE market:

• unemployment at historical highs (and still rising)
• retail sales still stumbling
• consumer confidence falling
• "asking" commercial rents falling
• commercial leasing activity (absorption) falling
• CRE sales activity: stagnant
• CRE values -43% from the high in 2007
• huge amount of CRE loan maturities over the next three years, with inadequate sources of credit to pay-off those maturities
• huge shortfall in CRE equity (such that it will not fill gap between the credit available and the looming CRE maturities)
• over 75 funds have been formed to buy distressed CRE debt and properties; but little it has been deployed
• very little CRE has been "re-priced" or "re-set" by lenders or servicers foreclosing or disposing of assets
• we're still early in the CRE recover (perhaps only 25% into the process!) (One interesting comment: remember that valuation adjustment occurs early in the CRE recovery process; so we might be 75%-90% into the valuation adjustment process.)
• importantly: no one on the panel, nor else where in the room, foresees an implementation by the Government of an "RTC style" approach (where the Federal government quickly closes large numbers of banks and thrifts, and then quickly sells the loans and assets at steep discounts – resulting in a "harsh pain" but quick re-pricing of CRE
• unlike the late 80s & early 90s: this time there is no new industry (such at technology) to lead the recovery by increasing employment

The audience was very quiet during this session.

BORROWER PANEL: "SURVIVOR"

This panel focused on "how" a borrower could make it through until CRE liquidity returns.

The panel has some advice for borrowers:

• show up with $ if you want to restructure your debt
• if you're in a good city, with good tenants and with DSC (get it?
• Use $ to right-size the loan), then you'll probably survive

It was interesting that while reference was made to splitting up a CMBS loan into an A Note (with good DSC & LTV) and a B Note (representing the "bad" part of the original loan), no one gave any details on the structure (such as the terms of the B Note, the proceeds waterfall between the lender [under the B Note] and the "new" equity [that injected capital needed, in part, to right-size the Note A], the rate of return on the new equity, etc.)

SURVEILLANCE & WORKOUTS: "LET'S MAKE A DEAL'

This panel didn't give any real guidance on terms of workouts, other than to list some basic rules of the game:

Do This:

• be nice
• send all information in; be open and transparent
• sign a pre-negotiations agreement
• keep paying cash flow
• have a reasonable, cogent plan BEFORE you contact the lender or servicer

Do NOT Do This:

• tell lender or servicer that you're "partners"
• tell lender or servicer that you're a good borrower
• "fish" for information or for terms of a plan that will be acceptable
• cry
• hold lender or servicer hostage
• ask for any of the cash flow (nor a cash flow mortgage)
• fly in on a private jet
• offer a bribe
• rob Peter to pay Paul
• launch off on a religious sermon (caveat: "the special servicer knows that it is going to Hell – every day is Hell")
• ask for any return on the new equity infusion made in borrower

It was an interesting day. Much like our experience in Munich – very little clapping at the end of any session (yes, it reminded me a little of the sessions at the EU conference that we attended in October 2008) [link]

In a future posting, I'll cover comments made to us by several elected and appointed Federal officials.

If you have any questions or comments, please post your comment below.

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(Part of my series on the capital markets.  Use the term "scorecard" in the search function on the lower right side of this page to find other postings in this series.)

On December 11, the US House of Representatives passed the financial reform bill.

As I've noted before, "tying" the loan originator or some other responsible party to the performance of individual loans in a securitized loan (CMBS) pool is critical to the "good" performance of the pool—which is a concept referred to as "risk retention."

The CMSA has been very focused on "who" could be the appropriate parties to have this risk of a loan going  bad. 

Below is the announcement made by the CMSA, as the financial reform bill made its way out of the House.

The risk retention provisions are an important step, BUT it only is a short-term band aid for the capital market freeze.  As a "fix" it does not address:

• the "tranche warfare" (caused, in party, by the inherent conflict of interest in special servicers affiliated with the CMBS B-piece holder) (granted, some of this is mitigated by the new approach to the "operating advisor" concept in the recent Developers Diversified Realty securitization; however, giving bondholder a degree of voting control over the special servicer is NOT nearly as effective result as the ability, in a covered bond structure, to replace the distressed loan with a performing loan; simply no comparison)
• the need for loan-level transparency and better communication between special servicers and investors
• the real "fix" for the problem is to allow the replacement of a problem loan with a performing loan (i.e., let's shift the focus from a backward look at the value of the "historical underwriting" by the B-piece buyer at pooling to a mechanism that fixes the problem as it happens—in the future)
• the fact that if a property is over-leveraged, and\or has debt service coverage problems, the problem is NOT with the capital markets—the problem is with the property  (i.e., the fact remains that commercial real estate markets will undergo market corrections; and that any "fix" should focus on softening the extreme "ends" of the ups\downs in the markets to the extent they are caused by the structures of financial products).  And this problem is the "pink elephant" in the room - and is a problem so vast that simply tweaking the CMBS model is not sufficient.  (It is the difference between a bar bell and a  tetrahedron. {Tetrahedron? I'll get to that in a minute.)

As I'll explore in future postings, I favor the use of "covered bonds" as the better long-term fix.  While this might NOT be popular to say, the CMBS model is NOT the long-term fix.

Mercy Jimenez and Spencer Punnett over at the Covered Bond Investor report "bipartisan support" for covered bonds at the hearing.  My reading of their report on the one (1) hour hearing does not convince me that pushing for covered bonds is a political reality right now.  As I gauge the political winds, the move to make the necessary Bankruptcy Code changes and changes to bank regulations (needed to protect or "circle" the bonded mortgages from issuer insolvency) is not a near-term reality.

So for the moment, we continue to band aid the CMBS model.  It is NOT the model that has enough credibility to return sufficient capital to the market in amounts that are needed for mainstream CRE, which some refer to as the middle of the "bar bell" - the trillions of CRE between the two extremes of properties in or nearing special servicing (on one end of the bar bell) and those properties having the best debt service coverage (DSC), loan to value (LTV) and tenants (on the other end of the bar bell).

As an aside, I don't see a "bar bell" in the market.  My visual picture is more of a tetrahedron, which also is some times called a triangular pyramid.  If that term sounds complicated, then you're well on your way to admitting that the current capital market for commercial real estate is no simple "bar bell" - where the cure is a "return" to the CMBS product (after, of course, tweaking it with risk retention, operating advisors and enhanced SPE provisions).

*          #--- #   **

* = the "best" commercial real estate

** = the "worst" commercial real estate 

# = the majority of the market (to the "right" of center or equilibrium with excessive leverage)

But back to covered bonds . . . .

Covered bonds are our ultimate destination for a capital markets solution that includes the middle majority of the CRE market.

Until then, we're only using a band aid.

We need to admit it, and get behind covered bonds - and pour over resources like the Covered Bond Investor.

(For more postings on my "CMBS Scorecard" series, use the term "scorecard" in a search of this blog.) 

Please post your own comments, questions or thoughts.

The CMSA Announcement

December 11, 2009—Today the U.S. House of Representatives passed sweeping regulatory reform legislation that includes language strongly supported by Commercial Mortgage Securities Association, tailoring financial reforms that would support a recovery in the commercial real estate finance market.

By a floor vote of 223-202, the House approved H.R. 4173, The Wall Street Reform and Consumer Protection Act of 2009, which encompasses large-scale reforms the Obama administration sought to prevent future financial crises and to regain stability in the overall U.S. economy.

As passed by the House, the bill includes language that would structure the ‘retention’ or ‘skin in the game’ requirement to account for the unique nature of commercial mortgage-backed securities. Specifically, the legislation grants regulators the flexibility to allow a third-party investor – or B-piece buyer – to satisfy the legislation’s new retention requirements.

Typically bonds rated below BBB are classified as “below investment grade,” otherwise known as the “B-piece.” The buyer of the B-piece takes on the highest level risk in a CMBS securitization because they are exposed to the first risk of loss. CMSA believes recognizing the role of these third-party investors who purchase the first-loss position and re-underwrite all loans during the pre-issuance period is critically important.

H.R. 4173 also includes another measure, one that would require the Federal Reserve and financial regulators to examine the combined impact of new retention requirements and new accounting standards (FAS 166 and 167) on credit availability, and to report to Congress with specific recommendations prior to any rulemaking on the retention.

“A risk retention provision that gives market and financial regulators flexibility in overseeing diverse asset types and structures is essential to support an overall recovery in commercial real estate,” said Patrick C. Sargent, President, Commercial Mortgage Securities Association. “Passage of this language by the full House today is a tremendous step toward restoring access to credit in this market,” he said.

“It is crucial that financial policymakers in Washington tailor reforms to recognize the role of sophisticated third-party investors that negotiate specifically for the riskier classes in a CMBS transaction,” Mr. Sargent added. “We encourage the Senate to support a recovery in commercial real estate by maintaining and strengthening safeguards in the CMBS market.”

The Senate has been working on financial services regulatory reform as well and they are expected to consider such legislation next year. 
 

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The CMSA has published the text of the testimony by Christopher Hoeffel, from his appearance yesterday before the US House Financial Services Committee.  As noted in my posting earlier this week (link), the Committee is investigating the use of the "covered bond" product as one tool to revive the CRE capital markets (and solve some of the problems with the CMBS model).

Here is a link to the testimony: LINK

The testimony is very instructive, and a must read.

I suggest that you research the covered bond.  We've been collecting materials for the last year.

If you have any questions, comments or help full materials on covered bonds, please post a comment.

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In an attempt to breathe life into the credit markets, the last few months have been full of activity designed to encourage the development of a market for "covered bonds" ala the European model. "Covered bonds" are merely borrowings by financial institutions (especially banks) that ultimately are supported as bank obligations, but are first repaid from a pool of specifically identified mortgage loans and their cash flows.

In Europe, the covered bond market has taken off over the last four or five years and is now at $1.7 trillion. The Fed and the Treasury, in attempts to stimulate the credit markets in the United States, have encouraged the development of a covered bond market with the FDIC proposing certain types of accounting and tax treatment to overcome the banking industry's concern about reserves, etc. At first blush, I thought, "Oh no, here we go, our government is getting involved trying to attempt to create a market after neglecting the abuses in the credit market for a number of years."

 However, on closer examination, it would appear that the covered bond concept would address a number of specific abuses that closed down the credit markets in the first place. First, the issuers of the bonds that are "covered," continue to own the underlying pool of mortgages (it is not a sale or securitization of those mortgages, but the pool of mortgages is pledged as security for the repayment of otherwise full bank obligations). In the covered bond structure, the banks still have "skin in the game" and own the mortgages. They are largely able to manage the assets because in fact the bank continues to own them and suffers the consequences of any eroding underlying value in the mortgage pool. Further, having a discreet pool of assets to back the bonds that have been issued, gives the covered bond investors some comfort regarding the overall eroding general credit of banking institutions.

While we should all be wary of our government going too far in "greasing the skids" for these types of investments, they do seem to be addressing the abuses of synthetic and derivative securitizations.

But do you think investors will bite?
 

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