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

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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Unlike the CMSA January Conference (where the primary focus is on addressing substantive issues) [link], the MBA-CREF convention has a primary focus on relationships: mortgage bankers meet with lenders; and lenders meet with mortgage bankers.

However, the MBA does offer some very interesting Committee and Council meetings, where substantive issues are discussed.

But make no mistake about this: the focus is on the meetings.

Any way, here are my notes from two committee and council meetings that I found particularly interesting today: the Public Policy Committee; and the Investor & Originator Council.

As a general proposition, the general "atmosphere" is much, much more optimistic than the atmosphere at the CMSA January Conference.

Maybe the credit markets have radically changed in two weeks.  (Or not.)

Public Policy Committee

• Legislative climate: bad. "Hostile environment" for lenders.  Lenders are "demonized" by the administration. No one wants to help Financial Services sector. With this background, here are MBA priorities: financial reform (big issue for CRE: risk retention provision - skin in the game; MBA try exempt multi-family & CRE); FHA role & mission (housing finance system); future of Freddie & Fannie (altho only briefly mentioned in comments to the proposed budget). Revenue raising tax issues are important to the Administration.
• Financial reform: House bill passed. Action now in the Senate. Bi-partisan working groups at work in Senate since November. Senator Dodd is not under political pressure due to his announcement that he will not run for re-election. Risk retention is focus of MBA. Calendar constrained because no hope for bills after August (due to mid-term elections). Plus other regulator reform happening, such as the "Voelker bill" (which will severely restrict the activities of banks).
• Need specifics on Administration's proposal to fund $30bill for community banks
• The MBA has a long, long list of regulatory and legislative items
• GSE: part of restructure of housing finance system; no "hard" direction from administration; the unlimited funding of Freddie & Fannie (per the Dec 10 announcement) will not continue forever
• MBA will formally oppose the fee on regulated institutions (but caveat: no one loves bankers)

Investor & Originator Council

At the beginning of this meeting, the MBA's economist (Jamie Woodwell) discussed the MBA's 4thQ data (to be released on Tuesday, 2/2); CRE loan originations up 12% on average; caution - comparing to a low level (in 2008); CRE originations still at low volume; maturity volume survey - 13% of non-bank will mature in '10 and 7% in '11 (highest product is variable rate CMBS); all to be on MBA's website.

Next, a panel of speakers gave their perspectives on the following:

• Buzz in market - things are getting better; what is your origination prediction for '10? Life Cos have almost normal funds (and spreads a good relative to corp bonds), but conservative underwriting will limit production volume; wild card is employment numbers
• Trends in last 90 days: sentiment in market is improved, w/ people wanting to invest; but challenged by worsening CRE fundamentals; tale of two cities (intense competition for best deals and no $ for bad deals); several big banks have approval to take loan applications for multi-borrower loans for CMBS pools (but same challenge - the same tale of two cities); strong investor demand for GSE bonds (a lot of capital looking for a home); need to see job growth in order for lenders to believe rents have stabilize
• Risk of double dip in '11: due to foreclosed properties hitting the market; at same time, some properties will attract investors if in good location or unique replacement cost (high quality asset); one panel member did not believe in "double dip" theory; good, performing loans are being sold at close/at par
• Will rising employment save the "kick the can" lenders? Banks need to see an accruing loan, and thus A/B note structures will be attractive; but this will take time to implement
• Rush to fix CRE is not the best strategy; lenders are taking the right approach in extending & restructuring (charge off the new B Note); average loss on foreclosure is 2x loss following smart restructure (if B motivated & doing the right thing, and a performing loan will be in place); however, this approach will affect price uncertainty; but lenders will foreclose (if B can not cure a $ default) and are motivated to sell REO
• Risk Based Capital for life insurance companies: regulators have given concessions and are working for a long-term solution
• FDIC: maybe considering keeping assets and working them out - as opposed to taking the "RTC" approach (from the late '80s)

This is a very different crowd, with a much more optimistic attitude, than the attendees at the CMSA January Conference.

If you have any comments, please post them below.

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(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.

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