No doubt, the 30,000 foot view on the way out of these troubled times for lenders is this: jobs, jobs, and jobs.

For commercial real estate, the corollary is this: the secondary housing finance market must be repaired, must be repaired, must be repaired.

(For a nice description of the "secondary housing finance market, read the description of the "second-layer lenders in the US" in the Wikipedia description of "Mortgages.")

Earlier this year, the Mortgage Bankers Association issued its report containing various recommendations on the Government's role in the future of the secondary (housing) mortgage finance market.

Recently, various officials from the MBA meet with senior officials at the Treasury Department to discuss those recommendations.  In the meeting, they also discussed the MBA's answers to the following series of questions from the Obama administration designed to elicit input on the future of the housing finance system (including Fannie Mae and Freddie Mac), and the overall role of the federal government in housing policy:

• How should Federal housing finance objectives be prioritized in the context of the broader objectives of housing policy?
• What roles should the Federal government play in supporting stable, well-functioning housing finance system and what risks, if any, should the Federal Government bear in meeting its housing finance objectives?
• Should the Governmental approach differ across different segments of the market, and if so, how?
• How should the current organization of the housing finance system be improved?
• How should the housing finance system support sound market practices?
• What is the best way for the housing finance system to help ensure consumers are protected from unfair, abusive or deceptive practices?
• Do housing finance systems in other countries offer insights that can help inform U.S. reform choices?

So, what is the "bottom line" for the MBA on the important question of the structure of the future housing finance market?

The MBA recommends a mixture of Government support and private markets:

"While we believe it is essential for a portion of the market to have a government guarantee to retain liquidity, it is also essential that private capital be at risk to ensure that lending is efficient, effective and responsive to market conditions. Additional concerns about capacity, funding, responsiveness and political distraction make it clear that a fully-government-based system would not be optimal."

You'll note that the MBA promises to continue meeting with Federal Regulators as they shape the new secondary (housing) finance market.

As I've noted in my other comments on the Dodd-Frank regulatory reform bill, the next year will be a portrait of change, all framed by meetings (meetings and more meetings) by industry organizations, lobbyists and others with Federal regulators, because Congress has (or will) empower the regulators to create the frame work for our "new" financial markets.

This will take some time.

If you view it differently, please post a comment below.

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Earlier this week, I posted a short summary of the Financial Services Reform Bill.   Since then, the House Financial Services Committee posted the text of the overhaul agreed by the House-Senate Conference Committee late last week:

• Now called the Dodd-Frank Wall Street Reform and Consumer Protection Act, the bill is both long (2,193 pages), and being pushed for a vote in the House before the 4th of July.

(Hip, hip, hurrah for the 4th!)  (Question: could you do this in a week - digest 2,193 pages, then think about it, complete the proper due diligence and investigation, and then vote on it - in one week?  Bonus question: could you do this after that week - tell your constituents that your really understood those 2,193 pages?) (Looking for those cliff notes . . . ?)

• So, to assist everyone (maybe even a few Senators and Representatives - or at least those with a busy extra-curricular schedule), the House Financial Services Committee also posted a 10 page summary [PDF] of the 2,193 pages..

We now have our summary.

If you have one work-related item to read this month, this is it. (Since you won't be voting on it, just read the summary . . . not the 2,193 pages.)

At this juncture,  we all start the hard work of figuring out "how" all of this will change the financial services industry; and how each of us will make a living, buy a house, etc.

One quick observation:

• some very important topics are pushed to the regulators (for their decision on important regulatory topics), which means we'll need to build in further delay and uncertainty in our business models pending those decisions

(First we blame and bleed the regulators in hearings staged for the 24/7 media coverage; and now we empower the same regulators or create MORE regulators. Is this political two-step simply an admission that we don't want to be responsible for the hard decisions? Or perhaps this simply is one political black hole in our representative government - the need to pass a bill and then climb the re-election podium?)

Happy 4th.

If you have some early predictions on the "how" flowing from these changes, please post them below.

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Everyone should be following (just read the front page of your local paper) the joint House-Senate conference committee [prior posts] as they work on the financial regulatory reform legislation. On Friday, June 25^th, the committee reached agreement on the legislation, with the goal of a House vote on it before the July 4^th recess.

No doubt, we’ll have access to numerous detailed summaries of this very, very important legislation.

In the meantime, you can review the legislative language considered by the conference committee at this link.

In addition, here is a short summary of highlights from the bill (prepared in part by the BuckleySandler law firm [link]) that are important to the financial services industry:

• Creating within the Federal Reserve Board (FRB) a new Consumer Financial Protection Bureau (CFPB) with rule making and limited enforcement power. Banks with less than $10 billion in assets will have a limited exemption from CFPB oversight. There are now exemptions in the bill for auto dealers and practicing attorneys.
• Instituting new minimum underwriting standards for mortgages and prohibiting certain compensation structures for mortgage brokers and originators.
• Exempting from new risk-retention requirements issuances containing only "qualified mortgages."
• Allowing the Office of the Comptroller of the Currency (OCC) to preempt state laws only if they "prevent or significantly" interfere with the business of banking.
• Eliminating the Office of Thrift Supervisionn, but retaining the thrift charter, with oversight of savings and loans going to the OCC and savings and loans holding company oversight transferred to the FRB.
• Establishing the Financial Stability Oversight Council to continuously monitor for systematic risks to the nation's financial stability. The council will also be charged with reviewing and commenting on accounting standards. Further, the bill gives regulators the authority to seize and liquidate large financial institutions that pose a systematic risk.
• Establishing new capital requirements and rules for trust-preferred securities.
• Placing restrictions on proprietary trading by certain large financial institutions.
• Under SEC rules, an accredited investor is defined as a natural person with an individual net worth, or joint net worth with a spouse, of $1 million or an individual income of $200,000 or a joint income of $300,000. The bill gives the SEC the authority to review the standard and update it to reflect inflation and the characteristics of the modern economy. The bill also excludes the investor's primary residence from the $1 million net worth standard. The SEC review may raise the threshold for defining a customer as an accredited investor, forcing companies that sell securities to them to register the products with the SEC.
• An amendment to the financial-reform bill would maintain state regulation of equity indexed annuities. Debate over the instruments, which guarantee an income linked to a stock index, centers on whether they are an insurance product or a securities product. The provision that was approved by the House-Senate conference settles the matter, barring the SEC from oversight. The products have generated startling stories of sales abuse over the years. Proponents say that the regulation has been vastly improved through a suitability model developed by the National Association of Insurance Commissioners. Registered equity-indexed annuities are not exactly popular products with broker-dealers, which is why insurers lobbied to get the amendment passed. And financial companies will now have more certainty about the regulatory regime they must follow when developing these complex products.

If you have seen other summaries, please post them (or links) below.

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(This is my last blog covering the CREF-C June Convention)

Below is a very random collection of information (and comments) as “take aways” from my attendance at this convention earlier this week. You'll note that I really don't jump into the CMBS 2.0 panels, nor into the special servicing panels. Why? Most of the content from those panels is not really new - or simply not that interesting to me. And there were a couple of panels that were so, so detailed - I simply can't drag you through it here.

So, on to random but hopefully interesting –

• Forums: the CREF-C is organized around interest groups that it calls “forums” [list]. Yes, the list is, in substance, remarkably similar to the MBA’s council structure. No real surprise in this look-a-like approach: as least with respect to commercial real estate, they are pulled by the same magnetic source.
• Portfolio Lender Forum (and focus): this list addresses topics of concern to life insurance company lenders, and has some real mind-benders and heart burn in it.  Generally, the life company mortgage lenders are being very cautious - and one reason is all of the uncertainty surrounding these issues -
  • NAIC Capital Adequacy Issues: this is the MEAF concept, the all-important risk-based capital requirement. As noted by the WSJ last week [subscription required], the MEAF subcommittee of the ACLI has recommended (for yet another year) some temporary relief in the MEAF requirements for 2010.  The WSJ reports that the action will reduce (for 2010) from 4% to 2.6% a proposed increase in risk-based capital for life insurers whose portfolios contain commercial mortgages. The original proposal would have cost the life insurance industry an addition 53% in capital; under the revision, capital would be roughly 12% higher than it was in 2009. However, a permanent solution is needed (a suggested approach is expected by this committee in August).
  • Rating Agency Experience & Stress Test Methodology: the complaint here is that the rating agencies simply do NOT utilize appropriate stress test on life company mortgage loan portfolios. For example, why do they use CMBS stress tests, designed for IO (interest only) loans, in the review of life company mortgage loans that amortize? And concern was raised at the perceived lack of experienced staff on the part of the rating agencies, which goes to their ability to thoroughly evaluate life company mortgage loans.
  • Government Sponsorship of Community Banks: this is a topic that I have addressed in several blogs [latest blog, which refers to other blog entries]. The bottom line here for the life company mortgage lenders: any government program supporting community banks will put life companies at a competitive disadvantage, and be a barrier to a “level playing” field.
  • Fair Market Value Accounting (new FASB rules): concern was expressed that this concept is not accurate in that unlike other investment products, such as bonds (which are a “trade today” approach), mortgage loans are a product designed using a “hold to maturity” approach. The general belief was that this change, which is being driven by the accounting world, will be implemented by 2013. My take away: this could be an additional reason to DECREASE mortgage loan allocations. Yes, less money available to the CRE industry. Not a good thought.
• Distressed Debt Sales – When?? Of course, this is THE question for many, many and many "opportunity" funds formed in the last 3 years, who have raised capital in hopes of great values (read: discounts) in the sale of distressed commercial mortgages from life companies and banks. The general consensus at the CREF-C convention: this is the second year for banks to stash cash as capital reserves, which should meant that 2011 will be the year when the banks will be able to (finally) sell “bad” mortgage loans at some sort of discount. What about life companies? Nothing was said – which I take to mean that life companies generally still are selling notes quietly, and selectively right now; but the volume is NOT large.
• Financial Reform: This should NOT surprise you, given that the CREF-C is pulled by the same magnetic force (commercial real estate finance) as the MBA – my summary of the MBA-CREF [link] was repeated; almost word for word. So, I’ll repeat it: [link]
• Better Attitude: yes, the JPMCC 2010-C1 deal had everyone in a hopeful mood [link] – but most people were still guarded given the experience of the tough times over the past several years. But hopeful. But expecting that the “lessons learned” from the Christmas Credit of 2004-07to be quickly forgotten and somewhat repeated – after all, this market is built on competition and repetition.

I hope this is of interest. If you have any questions or comments, please post them below.
 

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Overlooked by the recent focus on health care reform, and now by the financial reform bills (see my recent blog posts, is draft legislation prepared by Representative Minnick(D-Idaho). Known as "The Community Bank and Commercial Real Estate Stabilization Act of 2010," his draft legislation has circulated on the Hill but has NOT been introduced into the legislative process.

His bill is based upon this premise: the "too big to fail" approach, which bailed out the largest banks and supported the CMBS market, largely ignored one very powerful economic engine.

Who is this "lost" or forgotten group?  Hints:

• They have the highest concentration of commercial real estate loans (relative to risk based capital) among lenders
• They extend credit to a broad range of customers (not just real estate related)
• They are located near you - even on your Main Street
• Every week, the FDIC seems to close 5-10 of them

The answer: Community Banks.

Hundreds have failed over the last several years; and hundreds will fail in the new future - currently, the FDIC lists 775 banks on its list of of "problem" banks (nearly 10% of all FDIC-insured banks).

I agree with Richard Suttmeier's assessment that community banks are the next key to economic recovery.

In his recent blog posting, he articulates the important role played by community banks -

• The economy on Main Street is driven by small businesses, the housing market and local construction - none of which are "too big to fail" but when taken together . . .
• These are the engine of job growth in the private sector
• Without job growth on Main Street, the economy will struggle [my editing here: Suttmeier predicts a "double-dip"], and consumer spending will suffer
• Community banks are the key to lending to small businesses
• Thus, community banks are crucial to the economy on Main Street

Representative Minnick's bill seeks to address this oversight (or perhaps simply the relative inability of community banks to pull political levers, when compared to Wall Street and the largest banks).  Briefly, his draft legislation addresses two related goals:

• Jump start new lending on the small-balance commercial real estate sector

Here's a quick summary of his bill (as of several weeks ago - so this could change):

• Six-month pilot program of $3 billion, if successful, may be expanded to three years and upsized
• Only community banks will be able to access that part of the program aimed at seriously delinquent loans and REO
• US Treasury will guarantee bonds backed by pools of small-balance commercial real estate loans, including REO properties at community banks
• Program administered by a Board consisting of Treasury Secretary, Fed Chairman, SEC Chairman, FDIC Chairman and four industry experts appointed by President
• $10 million maximum loan size (or appraised value) per property
• Conservative loan underwriting and pricing
• Rating agency involvement to provide an independent view on underwriting and structure
• Treasury will charge a “guarantee fee” similar to Fannie/Freddie, of between two to three percent annually
• Any profit participation back to the originator must be earned over time

I also attach a much longer "term sheet" describing the proposed bill (there might be a more current version).

So, what do you think?

Please post your comments below.

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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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(Blogging from the MBA Servicing & Technology Conference . . . )

One phrase describes the majority of the content today at the sessions attended by me at the MBA Servicing & Technology Conference:  "Change is now . . . we just don't know all of the details."

My take away is that some very significant work needs to be completed before the "new" CMBS 2.0 will be implemented to any significant level.

Here are some examples from sessions today:

• Reconciliation of H.B. 4176 and S. 3217:  Representative Carolyn Maloney (D-NY) talked about the importance of the CRE market to the broader economy, and briefly mentioned the status of the reconciliation of the House Bill H.R. 4176 and the Senate Bill S. 3217 (prior posting on two bills).  My take on her talk?  Short on details on the all-important reconciliation, and not enough guidance on "where" we are going . . . but then this morphed into the general theme of the day.  (The Congresswoman nailed it: so, change is now . . . we just don't know all of the details.)
• REMIC Rules Need More Change - Unilateral Releases of Collateral:  One session raised the continuing need of the IRS to modify collateral release rules found in changes to real estate mortgage investment conduit (REMIC) regulations (Treasury Decision 9463).  This topic has been the focus of much discussion because the Treasury rule had the effect of imposing additional restrictions on collateral releases, when compared to the prior law - even when the release is expressly permitted under the loan documents.  Currently, the rumor is the that the IRS is prepared to issue a new announcement resolving this problem. So, change is now . . . we just don't know all of the details.
• FDIC Safe Harbor Only Part of the Story:  While the FDIC on May 11 issued a proposed rule to clarify the safe harbor protection in a conservatorship or receivership for financial assets transferred by an insured depository institution in connection with a securitization or participation, the FDIC is not the only regulatory body with a voice on this issue.  For example, FASB rules 166 and 167 may require consolidation of those same assets with the bank that originated the securitized loans.  ln addition, the SEC and the IRS may weigh in on the same issue.  So, change is now . . . we just don't know all of the details.
• Regulation AB - Much Work Ahead:  While this summary is short, the SEC's proposed changes to Regulation AB is @ 667 pages, and contains @ 300 questions.  One session here at the Conference devoted 15 minutes to generally describe the challenges in the proposal; and an entire session during Tuesday at the Conference will be devoted to (literally) working on it.  And much, much more work is being done by industry volunteers in analyzing and responding to the proposed changes.  So, change is now . . . we just don't know all of the details.

Some heavy listing needs to be accomplished.

Question: are you seeing this differently?  Please post a comment below.

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As you've probably already heard, on Friday (May 21, 2010), the Senate passed the "Restoring American Financial Stability Act of 2010" (Senate Bill S. 3217) by a 59-38 vote, but did so through a parliamentary twist where it deems the Senate bill to be a version of House Bill H.R. 4173 (the "Wall Street Reform and Consumer Protection Act of 2009"), which passed in the House last December.

So, now there are two versions of H.R. 4173, and it will go to joint conference to reconcile the House version and the Senate version.

A mind bending process - but one that I'm sure will make America great.

But also very simple when compared to the length of the two versions and the hundreds of amendments.

- Will the Senators and Representatives on the joint conference actually read all of this?

We know that their staff will read it all - and summarize it for them.  And, summaries will be furnished by others (such as the MBA, CREFC and other industry organizations connected to the commercial real estate industry).

- Would you, or will you, read all of this?

When the MBA and\or the CREFC publish summaries of this, I'll post them for your reading.

- Have you seen a summary?

If you have seen one, please post the url link to it below.

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As I've previously noted, rating agency reform is on the table and gaining momentum in the Senate.  The original Senate reform bill (the Restoring American Financial Stability Act (S. 3217)) included an increase in the oversight of the recognized credit rating agencies (referred to as the National Recognized Statistical Rating Organizations or "NRSROs").  Under the Senate reform bill, the NRSROs would be placed under the oversight of a new regulatory agency within the Securities Exchange Commission, which will include annual inspections and imposition of control standards.  But this is not enough for the Senate.  It wants more reform.

Last week, the Senate passed two amendments (described below) to the reform bill.  As you might suspect (in this 24/7 digital reporting world), commentators quickly jumped into the fray.  Here are several interesting responses, which (together with my favorite reform suggestions) point to "missing" pieces in the reform movement in the Senate - even after these two amendments:

• Impose Rating Agency Liability.  As noted by Mike Konczal (a fellow at the Roosevelt Institute) at Rortybomb, the Senate has not revoked or modified the rating agency "no liablity" protection under SEC rule 436(g).  This rule has been strongly criticized in a white paper published on behalf of the Council of Institutional Investors.  In his posting, Mike notes that the rule is abolished by the House reform bill.  Will this rule survive joint committee reconciliation and make it into the final reform bill?  My bet is NO.  Will the SEC revoke this rule?  My bet is NO.
• Require Investment Banks to Furnish Credit Analysis (With Liability).  Sanford Bragg with Integrity Research Associates suggests that the investment banks should be required to furnish (or make public) their own credit analysis of the offering, after noting that the investment banks already can furnish this information since they structured the offering.  He also notes that the investment banks also would pick up liability for incorrect analysis.
• Post Employment Limitations.   As I've noted before, rating agency employees should be restricted or prohibited from taking jobs with the investment banks.
• Loan Level Data Sharing.  As I've noted before, loan level information should be required to be collected and shared as data,  with the use of MISMO standards.

The two amendments passed by the Senate are the following:

1. Franken's Amendment: New Credit Rating Agency Board to Select.  Under an amendment sponsored by Senator Franken (D - MN), this new board would decide which rating agencies are qualified to rate structured bonds and then pick ONE of these qualified agencies do the job in each case.  This approach (where the board will select the rating agency for an issuance) is intended to stop the rating agency "shopping" by the issuer, who force the rating agencies to compete for the business as the issuer selects the rating agency.  The criticism of the "issuer selection\shopping" approach is that rating agency competition "conflicts" with the rating agencies role of properly assessing and rating the issuance.
   
   I agree with John Gapper of the Financial Times in his criticism of the Franken amendment.  Gapper notes the following in his blog:  "The trouble is, this is a strange way to go about it. It means that the agencies, as well as being Nationally Recognized Statistical Rating Organizations, will be given a further seal of approval by the Securities and Exchange Commission. That hardly seems to be the way to reduce their authority in the eyes of investors.  A better way to go about it, as I argued the other day, would be to remove their official status altogether and make them more liable for their mistakes . . . ."
   
   I totally disagree with Joe Weisenthal at Clusterstock, who views the Franken amendment favorably.
   
   Is the Franken selection as effective as simply imposing liability for rating agency mistakes? I don't think so.
   
   Also, Sanford Bragg's summary of the Franken amendment and the House bill is very good.  I like his suggestion of requiring credit analysis by the investment banks, with resulting exposure or liability for mistakes.
   
   Let's require the investment banks to keep some "skin in the game."
    
2. LeMieux"s Amendment: Drop Required Use of NRSRO.  In contrast to the Franken amendment's approach of imposing regulatory control over the selection of the rating agency for a particular issuance, the Senator LeMieux's (R - FL) amendment would do away with any required use of the rating agencies.  The amendment does away with any reference to NRSRO ratings from existing financial regulations.  For example, it would require regulators (such as the Federal Deposit Insurance Corp) to develop their own standards of credit-worthiness, rather than rely solely on credit rating agencies' assessments.
   
   This approach is like the approach taken in the House reform bill, and is summarized by Sanford Bragg as follows:  "The House approach is to remove the regulation and legislation that encourages the use of NRSRO ratings, distancing government from ratings. The Senate approach, through Franken’s amendment, inserts government in the middle of the rating process as a mechanism to reduce conflicts. While not wholly incompatible, the two bills have very differing underlying philosophies."

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

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On Wednesday, April 14, the White House and the HUD Secretary Shaun Donovan both took steps in support of reforms for the housing market (including Fannie Mae and Freddie Mac).  Here is a quick summary:

1.  White House Asks Public Input on 7 Questions:  The Obama Administration issued a press release asking for public comment on seven questions, all covering reforming the current housing finance system.  The press release asks us to submit written responses (via on-line), or to attend various public hearings (planned to take place across the country.  Take a look at the questions; they are interesting.
   
   Remember my point that mid-term elections restrict the time period for Congress to pass any financial reform; and that the window of opportunity to pass a bill closes in August (when Congress will focus on re-election).  So, why the need for a series of public hearings around the country? Given the huge numbers of foreclosures since 2007, do we really think that the public needs a hearing to prove-up or substantiate the need for housing financial reform?
   
   Perhaps the hearings serve another purpose: simply good local news coverage for those mid-term elections?  
   
   While I understand the need for theater and the desire to be re-elected, I just hope that the political playbill leaves some time to address the problem with meaningful legislation.  The clock is ticking and August will arrive before we know it.
   
   
2. House Financial Services Committee Testimony: Recall the testimony last month by Treasury Secretary Tim Geithner before this committee. 
   
   During this second hearing, the Secretary of Housing and Urban Development Shaun Donovan articulated the Obama Administration's goals for reforming the housing finance markets. (PDF of his testimony)  A portion of his testimony focused on the important role of Fannie Mae and Freddie Mac in residential housing.  He stated that “government support for multifamily housing is important and should continue in the future housing finance system to ensure that consumers have access to affordable rental options.”
   
   I totally agree on the importance of continuing the role of Freddie and Fannie. I just hope, however, that Chairman Franks does NOT wait another month for the third hearing - and doesn't delay his process while the Administration takes the political theater (#1 above) on a cross country tour.  At the hearing, Chairman Barney Frank indicated that there is broad consensus among lawmakers on the need to reform the current system and that the Committee plans "soon" to draft legislation addressing housing finance reform. I do hope "soon" really is soon.  The clock is ticking and August will arrive before we know it.

If you have any questions or comments, 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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On Monday (March 22, 2010), the Senate Banking Committee voted along party lines and passed the "Restoring American Financial Stability Act of 2010" (with a 13 to 10 vote).  So, Senator Dodd's financial reform bill makes its way out of the Senate Banking Committee.  And now the bigger battle begins.

But not before Committee members filed 473 amendments to the already lengthy bill (1336 pages).

Fortunately for us, the CMSA has updated its summary of the provisions of interest to its members.

Like the Commercial Mortgage Securities Association (CMSA), the Mortgage Bankers Association (MBA) has circulated a short summary of the bill, which focuses (as it should) on issues important to its membership.  (Note my blog last week covered the CMSA's initial summary of the bill).  The MBA's summary focuses on securitization, and attempts to revive the CMBS market (commonly referred to as "CMBS 2.0"). 

Succinctly stated, the MBA believes that "the market already has retained risk embedded in its structure and risk returns. In addition, we will underscore our position that an uniform approach to risk retention can create unintended consequences and stymie further efforts toward economic recovery."

Here is the MBA summary, as it focuses on those two positions:

• Reduces risk retention from 10% to 5%
• Requires separate rules for different asset classes - residential, commercial loans, etc.
• Provides for exemptions, exceptions and adjustments of risk retention for assets that are deemed to have high quality underwriting and in the public interest.
• The Federal Banking agencies (the OCC and the FDIC) and the Securities and Exchange Commission (SEC) are required to jointly prescribe regulations to mandate that any securitizer retain an economic interest in a material portion of the credit risk for any asset through the issuance of an asset-backed security (ABS) that is transferred, sold or conveyed to a third party
• These regulations must: 1. Prohibit a securitizer from directly or indirectly hedging or transferring credit risk that the securitizer is required to retain with respect to an asset; 2. Require a securitizer to retain: a. not less than 5% of the credit risk for any asset that is transferred, sold or conveyed through issuance of an ABS by the securitizer; b. less than 5% of the credit risk for an asset that is transferred, sold or conveyed through issuance of an ABS by the securitizer if the originator of the asset meets the underwriting standards that must be established by the regulator that specify the conditions, terms and loan characteristics within each asset class that indicate a "reduced credit risk" with respect to the loan; 3. Specify the permissible forms of risk retention and the minimum duration of the risk retention, 4. Apply regardless of whether the securitizer is an insured depository institution, and 5. Provide for: a. a total or partial exemption of any securitization as may be appropriate in the public interest or for the protection of investors; and b. the allocation of risk retention obligations between a securitizer and an originator in the case of a securitizer that purchases assets from an originator, as the Federal banking agencies and the SEC jointly deem appropriate.
• The definition of an originator is "a person who sells an asset to a securitizer."
• The effective date of the regulations would be 2 years after the publication date for the commercial market.
   

Click here for a copy of the MBA's press release covering its position on that the bill needs a more explicit risk retention exemption for mortgages [download] and for a copy of the MBA's summary of the risk retention provisions in the bill [download].

After the tough battle over health care, it will be beyond interesting as we watch Congress go to the mat over financial services reform - and hopefully legislation that supports recovery of the CRE finance markets and the economy.

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

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On Monday, March 15, the Senate Banking Committee released it's draft of the "Restoring American Financial Stability Act of 2010" [click name to download it]. 

It is long: 1336 pages.

And no surprise at this: it is complicated.

Provisions include creation of a consumer protection watchdog housed in the Federal Reserve; creation of a nine-member Financial Stability Oversight Council chaired by the Treasury Secretary; an “advanced warning system” for systemic risk; an end to “too big to fail;” increased transparency and accountability for “exotic” instruments such as derivatives; streamlined federal bank supervision; increased regulation of credit rating agencies; and a “say on pay” provision for shareholders on executive compensation

Fortunately, the Commercial Mortgage Securities Association (CMSA) furnished a preliminary summary of the bill [click to download it] - it is 11 pages.

Note, however, that the CMSA summary focuses (as it should) upon issues important to its members.  So, if you are a bank or a life insurance company, you probably need to reach out to your industry advocate group for details of importance to you.  (Did I say "this is complicated?")

Here is the summary of the summary furnished by the CMSA (further proof that this is complicated):

• For ABS, including CMBS, a reduction in the retention requirement by “originators” and/or “securitizers” from 10% to 5% and a clarification that this applies only to securitized loans;

• A requirement that regulators (the OCC, the FDIC and the SEC acting jointly) tailor retention rules by “asset class";

• Regulator authority to lower or eliminate retention if “underwriting standards” (as jointly established by the regulators) are satisfied, or if the regulators jointly find that the reduction or elimination of the retention is appropriate for any other reason;

• Enhanced Credit Rating Agency transparency for investors and related operating requirements;

• Modification of Treasury’s proposal that the SEC direct credit rating agencies (CRAs) to “differentiate” ratings with a requirement that CRAs disclose the basis of ratings and that symbols be used consistently across the types of securities to which they apply (with the CRA discretion to differentiate if chosen). 

Remember, the House already passed financial reform legislation last fall.  So, this bill will be debated in the Senate, and then if it passes, it'll go to joint committee for reconciliation.

No doubt, we'll be reading much about this from many sources.  In the interim, here are my quick thoughts:

• Time is short, and the mine field already is full of controversial issues (such as health care).  Mid-term elections are approaching; and after August, a significant portion of Congress will have one thing in mind: re-election.  And thus no time for financial reform.
• This is a long, long, long bill.  This is complicated.  One criticism of the American Recovery and Investment Act [track it here] was that it was long and complicated.  A topic as important as financial reform needs careful consideration.  This just strikes me as too much with not enough: is there really enough time and attention bandwidth in Congress to give this topic the proper consideration?
• U.S. Senate Banking Committee Chairman Chris Dodd (D-CT) is not running for reelection. He is the key in keeping the necessary focus, and in acting as the moderator and mediator in this process.  This is good.  But, as the next bullet shows, he isn't pulling the other side of the aisle with him (yet).
• But I still come back to this point: is a 5 month period (full of other political issues) really enough time to vet a Senate Bill and a House Bill, and then to overhaul the financial services industry?  This is an overhaul of a very, very important industry.  Sure, other topics in front of Congress are important, such as education and the overhaul of the "no child left behind" bill.  But will the net effect of a financial reform bill, passed under intense time pressure, simply give us a financial services industry "left behind" in a very competitive world economy?  The "new" world order no longer has the US imposing our will on the world financial markets.  There's real competition now.
• Already, the committee’s ranking Republican, Richard Shelby, R-Ala., and nine other Republicans on the committee sent Dodd a letter saying the proposed timetable does not give members adequate time to understand the scope of the proposal: “Given the sheer magnitude and complexity of the financial reform package you intend to introduce, this legislation will inevitably have a substantial impact on our financial system and overall economy. Accordingly, we urge you to allow for sufficient time to review the language.”

This is complicated.

Please post your initial thoughts, comments, and questions blow.

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Yesterday, the Commercial Mortgage Securities Association (CMSA) submitted a comment letter [download] to the FDIC concerning the FDIC's 'Safe Harbor' rule [down load the FDIC's Advanced Notice of Proposed Rulemaking] covering the securitization of commercial real estate loans. 

Of course, the CMSA is not the only industry organization to comment on the FDIC's proposed rule.  For example, Housing Wire [link] describes comments to the proposed rule raised by the American Securitization Forum, the Mortgage Bankers Association and the Securities Industry and Financial Markets Association.

The FDIC's proposed rule is designed to isolate, from the failure of a bank, the underlying assets of securities held by the bank.  The treatment by the FDIC of assets transferred by a bank in connection with a securitization, and the subsequent failure of the bank, is an underlying building block for securitization - simply because investors will NOT buy CMBS bonds if the underlying loans may be stripped from the CMBS pool, if the bank that originated the loan goes into FDIC conservatorship or receivership.

Under the proposed new rule, the safe harbor would be amended to include numerous preconditions regarding a transaction’s capital structure, disclosure, documentation, origination and compensation.

I really don't have anything to "add" to the pointed comments made by these organizations .  If you want the "detail" on their perspectives, I've furnished you the links (above).  (They contain some very, very interesting points.)

My focus is on the following statement in the CMSA' e-mail announcing its comment letter:

"[The] CMSA suggests that the FDIC work in concert with Congress, the Obama Administration and the other agencies that are developing securitization reforms to ensure that FDIC's safe-harbor efforts do not lead to a regulatory framework of conflicting or overlapping requirements that may impede the restoration of functioning credit markets."

My read of the situation remains unchanged:

• unlike at the creation of the CMBS model in the early '90s, the financial crisis and the role of CMBS 2.0 in it is a political process - which means a large number of parties have a voice in the process
• the changes needed to restart the CMBS model (referred to as "CMBS 2.0") are not easy
• mid-term elections mean that Congress will NOT address this critical component of the credit crisis once the heavy campaigning begins (in August) . . .
• . . . which leads to the conclusion that in 2010, we will NOT see a return to a meaningful CMBS market.  In other words, no CMBS 2.0 for the small commercial real estate borrower.  Sure, single sponsor deals with the best DSC, LTV and other uber-credit criteria will be launched (good for Wall Street).  But a multiple borrower pool of small loans (help for Main Street)?  I say not in 2010.

I hope that I'm wrong.

If you view it differently, please comment below.

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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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(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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More on my series commenting on the CMBS loan market and the broader capital markets for commercial real estate . . . .

Previously, we've brought to your attention a type of commercial real estate debt structure that HAS worked in the EU (for hundreds of years), and it HAS been tried at least twice in the U.S.  [link to prior posting]

It is called a "covered bond." 

Click here:  Wikipedia has a good description of it .

Covered bonds offer the best hope for improving the current capital grid lock, which has the commercial real estate market on its knees.  Covered bonds will be an important piece of the credit stack for the U.S. commercial mortgage market.  It will help the commercial real estate market recover.

We've meet with a EU bank that handles this product (during our trip to the EU in 2008) and we've closely followed this important topic since the then.  So, stay tuned.  We'll write more on it.

All that you need to know right now is that covered bonds are similar to CMBS pools, with this important difference: the issuer (read: the original lender) retains some risk on the performance of the pool.  This means that the issuer services the individual loans and literally cares for the loans—yes, this is the "retained risk" phrase that you'll start to read about.  For example, when a loan in a mortgage bond pool goes "bad," the issuer can swap out the "bad" loan with a "good" loan.  (What an idea!)  Sure, there are hurdles to this concept in the U.S., including probably amending the U.S. Bankruptcy Code.  And the public probably is in no mood to do that right now.  But as the real estate "recession" extends into 2010 and beyond, the time will come . . . .

 . . . maybe sooner than later.

A recent announcement from the CMSA (Commercial Mortgage Securities Association Web site) got me going today on this topic - tomorrow the U.S. House Financial Services Committee will hold a hearing entitled "Covered Bonds: Prospects for a U.S. Market Going Forward."  Here is the CMSA announcement:

"CMSA Executive Committee Member and immediate past president Christopher Hoeffel will testify before the full House Financial Services Committee on Tuesday, December 15 at 10:00 a.m. ET. The hearing, “Covered Bonds: Prospects for a U.S. Market Going Forward,” will provide a forum to discuss how such a market could be structured in light of current changes and the recovery efforts occurring within the financial markets.  For its part, CMSA supports efforts by policymakers to facilitate a U.S. commercial covered bond market in order to provide an additional source of liquidity through new and diverse funding sources, and the association continues to advocate for the inclusion of commercial mortgages in a covered bond market.  Mr. Hoeffel’s remarks and the hearing itself can be watched live through the House Financial Services Committee’s video sever shortly before the 10:00 a.m. ET start-time December 15."

IF Congress and IF the American public can stomach including covered bonds as part of the financial reforms, then the commercial real estate market will finally have some capital relief.

There is hope.

If you have thoughts, comments, questions or resources covering covered bonds, please post a comment.

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By now you should be well aware of this "bad" fact stemming from failure or lock-down of the CMBS loan market:

• Between now and the end of 2012, more than $600 billion CRE loans will mature in EXCESS of the average 3-year historical gross originations from all non-commercial CRE lenders.  In other words, in the absence of a CMBS loan origination market, +$600 billion of CRE loans will mature with no historical source for pay-off (See PDF).

In other words, if the loan is within the tight bandwidth of the best underwriting standards (for example, high debt-service coverage and low loan-to-value), then the loan probably will find a refinancing source.  If it is not, then there simply isn't credit available to repay the loan.  Thus, the lender\servicer has two choices: extend the loan or foreclose.

This gives you a good perspective of the "why" behind the "extend and pretend" approach adopted by banks and CMBS servicers.

So, for all those loans that are not in the tight bandwidth, where are we on the all-important topic of jump starting or replacing the CMBS market?  (Show us the money)

Here's a quick scorecard that indentifies a few recent milestones:

• New CMBS Issuances!!  Yes, two new issuance of CMBS hit the market last week.  It has been nearly two years since the last sale of new CMBS issuance.  While it is an important first step, the DDR Depositor LLC Trust 2009 Commercial Mortgage Pass Through Certificates (series 2009 DDR1) signals little hope for the typical CRE investor: this CMBS pool is a single sponsor structure, with low loan-to-value (@ 62%), great debt-service coverage (@ 1.4x), and a significant percentage of investment-grade tenants (@23% of total square footage and @15% of base rent).  And the same can be said of the second issuance, which was the Bank of America Large Loan Trust 2009-FDG.  The BoA deal was a single, seven-year, fixed-rate non-recourse loan to entities of Fortress Funds.  Neither issuances, however, involved a pool of small loans from a wide variety of borrowers.  While something is better than nothing, these two issuances do not signal immediate help to the typical owner (Link to CMSA summary).  Bottom line: great news for Wall Street; no help for Main Street.

• Basic Changes to the CMBS Model - Risk Retention. The Hill seems to be listening to the CRE industry.  In September, the CMSA issued a white paper (PDF) giving input on the 2009 Financial Regulatory Reform proposals currently being studied by Congress—but from the perspective of the commercial mortgage market.  Last week, the House Financial Services Committee passed an amendment to the reform bill that (i) places the risk retention requirement at 5% and (ii) recognizes third-party investors (who purchase the first-loss position and re-underwrite all loans during pooling) as proper holders of the risk retention piece.  This is a important victory for the CRE industry.

• Rating Agencies in the Spotlight. Part of the reform includes changes in the role and function of the rating agencies.  My perspective is that we really haven't heard much from the most important player in the mix: the investor. (The party who literally "buys" the CRE investment, whether in the form of a CMBS bond or a limited partnership interest.) For a hint of the investor's perspective, read this white paper (PDF) from the Council of Institutional Investors (website).  It strongly argues for more accountability on the part of the rating agencies.  At the very least, this points to the fact that the "re-examination" of the CMBS recipe is wide ranging.  And with topics such as rating agency liability on the table, I doubt that there will be a quick fix.  And, as noted above, the "table" is located on the Hill,  which is not a friendly banquet hall for commercial real estate . . . .

• More Extend and Pretend. What does a "no quick fix" mean?  Navigating the CMBS ship through the political process will NOT be a quick trip.  Consequently, for loans that are nearing maturity, or are in distress, the rescue plan will involve the current lender for the next 12 months.  At the loan level, it will take creativity and a thorough understanding of the market and the lender\servicer constraints (such as the new guidelines for banks or the PSA limitations for CMBS servicers), in order to keep the loan out of foreclosure.

 Please post your thoughts or comments on other key markers that you've seen.

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