(This is part of a series of postings from the 2009 MBA-CREF convention in San Diego.) (Trends; Arriving; Day One; Day Two; Day Three)
It is no surprise that the convention is markedly different from previous years. Everything has changed (unfortunately that's almost NOT a terrible understatement): lenders have a new focus (and those with "real" investment allocations to lend are few in number), servicers are under scrutiny in the face of looming defaults, and mortgage bankers are seeking ways to serve (read "save") their best borrowers.
Kudos to the MBA for directly addressing these changes and challenges. The sessions were informative. The discussions were frank. Too bad attendance at the convention is down.
Here are some of the topics, observations and comments:
- Servicing is servicing. While servicing CMBS clearly has unique twists and challenges (such as the servicing standard of care, "tension" among the investor classes, etc.), portfolio lenders and CMBS servicers share many common hurdles in dealing with troubled loans. (My next post will address some frequently asked questions about dealing with troubled CMBS loans.)
- The erosion of credit and value is a critical challenge. Yesterday's debt service coverage and loan to value definitely is not today's story.
- The stack of first lien mortgage, mezzanine debt and even holding company leverage, which I affectionately call the "Other People's Money" mantra of the "old" economy, is yesterday's story and today's headache. In prior conventions, sessions focused on these "tools" of the finance market. This convention didn't even mention it - for good reasons: we're now dealing with the hangover.
- It is difficult to identify the correct asset disposition strategy when relative values are difficult to determine - values seem to change weekly. In all sectors (products) and markets, appraisal valuations are problematic.
- Life companies are placing greater emphasis on debt service coverage, with less reliance on loan to value measures.
- The ability of borrowers to pay off a loan at maturity (the inability to pay is called a "maturity default") is under question due to the fear that community and regional banks are tapped out in their ability to place mortgage debt on their balance sheets. And since these loans are limited term floaters, with equity pay-downs and guaranty agreements, they are only a temporary "fix" to the larger credit problem. In other words, the boomerang remains in the air.
- Generally, the strategy of CMBS servicers and portfolio lenders is this: extend (if possible), wait and increase surveillance. However, an extension has a price: new underwriting of the market, the project and the sponsor, with an extension fee, new reserves, lock box structures, amortization, etc. An extension needs to make sense.
- Regulatory reform is coming. For the life company, this means possible changes to risk-based capital (and the dreaded "mortgage experience factor") and possible "opt in" Federal licensor. For the CMBS servicers, this means possible REMIC reform (again) addressing seller financing, control over the special servicer, etc.
- The need for greater information flow. For the life company, this plays out in rating agencies asking for loan level information - like the information available in CMBS pools. This second guess is totally new for life companies. (For years, I periodically ask my life company clients: do you want outside counsel to prepare a loan and property summary like the ones we prepare when we close a CMBS loan? The prediction here is that the time has come for this change.) For CMBS servicers, investors are asking for even more loan level information. They've learned that they can not simply "trust" the certificate rating - they need to understand the current status of each loan in the pool (beyond the data contained in the current investor reporting package).
- Note sales are problematic. On the CMBS side, they have slowed, with a wide gap between the bid and the ask price. It was noted that there exists a correlation between AAA CMBS spreads and the volume of note sales. Thus CMBS prices need to stabilize in order for loan sales to increase. On the portfolio lender side, the risk-based capital rules literally rob the portfolio of the ability to craft loan restructures that place the lender in a position to increase its yield (and profit from a rebound in the market).
- Life company underwriting is now a return to the basics: 1.50x minimum debt service coverage; maximum 55% maximum loan to value (slightly higher for multifamily); shorter term; avoid hotels; beware of retail and "transitional" projects (which is a problem for banks seeking takeouts for construction loans); closely examine employment base of local market; scrutinize debt maturities of the principal; consider the use of lock box and SPE structures; less reliance on appraisals (due to valuation challenges) and more reliance on debt service coverage; etc.
This convention has been "rich" - not in the sense of money being thrown at deals (as in prior years); but rich in information, determination and the resolve to navigate these challenges.
The unspoken mantra seems to be: we can do tough times.
