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

(Blogging from or about the MBA Servicing & Technology Conference . . . .) (Day One blog) (Day Two blog)

On the first day of the conference, I had the pleasure of being on a panel with Bill Frazer (CBRE Capital Markets), Steven Bean (Situs Realty Services, Inc) and Catherine Rodewald (Prudential Mortgage Capital Company).  Each is a leader and expert in uses of technology in servicing commercial mortgage loans.

The topic of the presentation was "Using Technology to Improve the Servicing Process."  The panel was charged with (1) focusing on what’s currently working and what has revolutionized servicing and (2) addressing the changes technology has brought to the servicing sector, with a look at the technology tools that can have a dramatic impact on every step of the commercial loan servicing business for all levels of servicing - including dealing with distressed loans in special servicing.

And I was on the panel.

• What was a lawyer doing on the panel?
• How can lawyers use technology to improve the servicing process?

This topic, and variations of this question, have been a quest of mine for almost ten years.  (And yes: 99% of the time I've more closely resembled Don Quixote than Steven Jobs.)

The answers to these questions are very simple:

• Lawyers need to deliver work product using the same technology tools utilized by the client
• My role on the panel was to give this startling message to the audience, and to "show" them one of the technology tools as an example

But first, here's some important back ground on the "need" for information (even legal knowledge)as data, and the role of lawyers as "producers" and conveyors of legal knowledge as data:

• Joseph Rubin with E&Y published a white paper (@ 6 years ago) on the impact of technology on operational efficiency and profitability in the commercial mortgage finance industry.  The paper shows how better uses of technology will solve "points of pain" in loan origination\underwriting, closing and securitization.  (Comment: it is no major leap to include dealing with distressed debt in this list).  The paper is fantastic.
• The Mortgage Bankers Ass'n jumped all over these concepts and formed the Mortgage Industry Standards Maintenance Organization, which is tasked with creating "data standards" that will allow companies to seamlessly communicate or transfer data from one company to another (as "trading" partners).  The members of MISMO are a "who's who" in the mortgage lending industry.
• Like Joseph Rubin, legal and technology thought leaders (such as Richard Susskind and Mark Chandler) all point to the changes that technology will bring to the delivery of legal services to clients
• Social networking tools (like this blog and our website where we give clients access to our papers and speeches on distressed investments) now allow lawyers to share knowledge - at no charge to clients (for free access to those materials, look at the "client resources" tab at the top of this page)
• Collaboration tools (such as Microsoft SharePoint, Realworkspaces and other "deal" or document "rooms") give the business community and their lawyers the ability to easily work together (if you are a lawyer, I highly recommend this book: The Lawyers Guide to Collaboration Tools and Technology)
• All of this supports the movement toward greater transparency, which I've blogged about in the past - including a blog on the proposed SEC rule for CMBS lending ("private is the new public")

Now, back to the reason to include a lawyer on a panel with technology experts (and leaders in companies built on sophisticated technology tools) like Bill, Steven and Catherine.

My presentation to the @ 100 people in the audience was very simple:

1. Lawyers should be expected to use technology to generate legal knowledge as data - as a new legal deliverable.  We're doing this right now for a large special asset group, where we collect status reporting on foreclosures and related litigation from outside legal counsel located across the nation.  Our learning curve has been steep, but we're (finally) focusing on reporting functionality that has only a few "clicks" in it, together with a subscription service feature.
2. Lawyers should be expected to use technology as a helpful training and knowledge sharing tool.  Over and over again, General Counsel asks outside counsel for information - and at no cost.  There are numerous technology tools for this knowledge sharing.

I'm very, very excited to see "how" all of this plays out. 

Lawyers can face these changes with ignorance and fear; or jump in the fray and explore ways to use them in the same way as clients use them.

If you have you own story, please post it below.

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As I've noted in in a prior posting, the informed borrower might have some angst about using technology for the public disclosure of loan level information - although (for example) you will be amazed at the amount of information available on CoStar and other databases built by the brokerage community.

But from the perspective of the lender or servicer handling distressed loans, technology will bring solutions to some very pressing problems.

This movement to use technology to solve points of pain in commercial real estate was foretold by a great white paper written by Joseph Rubin with E&Y.  (I've had this paper since 2005 - so it is a least 6 years old.)

This paper literally opened my eyes to "how" technology will impact commercial real estate.

Once you read Rubin's white paper, you'll have a deeper understanding and appreciation of the technology and transparency movement in commercial real estate, and an understanding that the SEC's proposed rule on loan level information disclosure simply is an extension of Rubin's paper (in addition to being responsive, in part, to investor demand for more and better information).

Indeed, the  push for common data standards (or "language" where a computer can transmit data to another computer without human involvement [referred to as  "B2B"]) through MISMO is closely related to the problems, concepts and solutions articulated by Rubin in his paper.

Sure, none of this directly addresses technology uses in CMBS special servicing, bank special asset work or distressed investments, but there currently are uses of technology that address the same or similar problems and solutions covered by Rubin.  Yes, technolgy helping to solve problems.

These technology tools include:

• blogs (like this one) (training)
• on-line libraries containing papers, speeches and other materials on distressed investments (like the Winstead resource materials site [look at the "client resources" tab at the top of this page]) (training)
• legal collaboration sites, which collect or aggregate legal blogs, papers, etc. (such as LegalOnRamp and Martindale-Hubbell Connected) (training)
• on-line, restricted access sites where companies and law firms post documents and information as data (like our VistaSync tool) (document collaboration; data collection)  (Note: I'll be discussing our tool next Monday at a 4p panel presentation at the MBA Loan Servicing & Technology Conference)

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

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In an earlier posting on CRE finance reform and market trends, I stepped back and asked the all-important questions:

• What does all this mean?
• What is the big-picture?
• Where is this going?

I offered up four perspectives, with these as the first two –

1. The Good: the “return” of the unregulated lender

2. The Bad: extend and pretend” will continue due to more and more CRE defaults.

My third perspective is much more controversial, and probably will not receive explicit recognition nor acknowledgment by many:

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, and as a source of finance for Main Street borrowers (i.e., CRE owners other than the large funds, REITS and institutions).

In earlier posting covering this third topic, I posed some tough questions from the perspective of the CMBS Investment Grade Bondholder.

Below are just some of the challenges facing CMBS 2.0, framed from the perspective of the other the most important players in the CMBS structure -

From the Borrower: without this player, there are no loans to place in a CMBS pool.  Here are a few of the concerns from the Borrower side of the table:

• Will the loan servicer be more responsive in the new CMBS 2.0 than my servicer in CMBS 1.0? You talked about my complaints about poor service at your CMSA conferences; but have you found a solution?
• Will the new CMBS 2.0 give us more flexibility, such as partial releases, substitution of collateral, future funding, etc.? When will you realize that commercial real estate changes almost daily and that the scale or number of loans in your CMBS pools are vastly different from your credit card, or a home loan pools? (Perhaps commercial real estate is NOT as fungible as you assume.)
• Why should I use the new CMBS 2.0 as a financing source? Unless, of course, you throw money at me . . . like last time. Or, simply offer me a great rate.  Right now, I need access to credit, so  . . . yeah, I'd do another CMBS loan.
• If the new CMBS 2.0 contains tougher loan terms (such as mandatory lock box\cash management from day one, agreed receiverships [with powers to market and sell], etc.), what makes you think that I’ll accept those terms? (Unless, of course, you throw money at me . . . like last time.)  Maybe I'll simply do a new CMBS 2.0 loan if it is my only source of financing.
• Disclosing Information About My Property:  If the "private is the new public" (in that the SEC will require the new CMBS 2.0 to disclose my loan level information both at securitization AND during the life of my loan), then how will this effect the ability of my property to compete (relative to other properties)?  Do lease brokers really have the terms of all of my leases, and are they really sharing this in the market place?  Has the digital age really invaded my space? Wow.  I had no idea.  Will banks and life insurance companies also follow this disclosure path?  If this really is a problem to me, I'll need to negotiate non-disclosure terms into my loan documents, which means . . .  CMBS 2.0 will NOT be an option for me.

These are tough questions.

• But: what questions am I missing from the potential CMBS borrower?

As I've noted before, when you combine the questions from the Investment Grade Bondholder with the questions from the potential borrower, we don’t have an elephant in the room – we have a herd.

If you have additional Borrower perspective questions, or other comments or observations, or your own questions, please post a comment.     

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Rating Agencies continue to be under a microscope. Here are two recent events, and two points that should be of interest:

1. Moody’s Receives a Wells Letter
2. Information Sharing Under New SEC Rule 17g-5 Addresses Conflicts of Interest
3. Needed: Post-Employment Limitations On Rating Agency Employees Deserve Consideration; and
4. Needed: Rating Agency Focus On Loan Level Fundamentals (Using Databases)

Five year ago, would you have foreseen the following?

1.  SEC Sends Moody's A Wells Letter; Cease & Desist Coming Next? ZeroHedge reports  on the disclosure by Moody’s, in its 10-Q, that it received a “Wells Letter” on  March 18, 2010.  The 10-Q states:

“MIS [Moody's] received a ‘Wells Notice’ from the Staff of the SEC stating that the Staff is considering recommending that the Commission institute administrative and cease-and-desist proceedings against MIS in connection with MIS’s initial June 2007 application on SEC Form NRSRO to register as a nationally recognized statistical rating organization under the Credit Rating Agency Reform Act of 2006.” 

ZeroHedge notes that this could be the “end for the rating agency.”

Separately, Market Pipeline quotes other portions of the 10-Q, which read like a bad dream for Moody’s.

Wow.

The European Union already is extremely upset with the US rating agencies.  This will only add to their anger.

2.  Conflict of Interest Addressed By New SEC Information Sharing Rule (new SEC Rule 17g-5): Jim Flaherty reports on the Commercial Real Estate Finance Council's "After-Work Seminar - SEC Disclosure Requirements" covering the new SEC Rule 17g-5.  This rule is designed to address the conflict of interest that rating agencies have as a result of issuers paying for ratings. It goes into effect on June 2. Here is Jim’s summary:

“The rule requires issuers and hired rating agencies to maintain password-protected websites to share rating information with non-hired rating agencies.

Here are the rule’s objectives (as summarized by Jim):

• Increase the number of ratings for structured finance products,
• Promote issuance of unsolicited ratings and
• Reduce the ability of issuers to obtain better than warranted ratings by exerting influence over hired rating agencies.”

Jim gives a good summary of the seminar, including a summary of the presentation on Rule 17g-5 and a copy of the presentation – read his blog.

This is a great break through for those of us supporting, and working on, data standards in support of B2B information sharing in the commercial real estate industry.   It also is another example of the transparency movement.  (See my earlier posting on CMBS loan level information disclosure.)

3. Needed - Post-Employment Limitations: I suggest that this additional step be taken - just as with the restrictions placed on Federal employees, rating agency employees should face limitations on taking a job at an investment bank or any other company arranging or involved in the issuance of securities.

Is this idea under consideration?

4.  Needed - Rating Agency Focus On Loan Level Fundamentals (Using Databases).  Rating agency focus during CMBS 1.0 seemed to be on the financial structure and payment waterfall (among the bondholder class and the servicers) with  very little focus on the equally important underlying real estate fundamentals.

Am I incorrect in my belief that the rating agencies did not focus on real estate fundamentals?

My suspicion is that since so little of the loan level information (covering real estate fundamentals, such as lease issues, title issues, etc.) was in a database format, they really did NOT have the ability to focus on bedrock real estate issues.

There is an easy technology "answer" for this challenge: require the collection of loan level information as data, and the use of MISMO standards to achieve this information sharing.

Note that I experimented at collecting title, survey, lease and other legal information in a database format.  But the loan originators did not recognize the value in doing so.  Surely this will change in the near future.

If you have other observations or suggestions, please post a comment below.    

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In an earlier post, I commented on a proposed SEC rule that will require the disclosure of specific loan-level information as data, at CMBS securitization and then during the life of the CMBS pool.  In addition, the data will be needed to "support" certain certifications required to be delivered as part of the CMBS securitization process.  Also, the disclosure requirements cover both public AND private CMBS structures.  (Yes, a "private" CMBS deal must implement the same data collection [between the parties to the private deal] as implemented in a public CMBS issuance.)

Read the proposed rule: it will blow you away.

The purpose behind the rule is "transparency" - so that investors can better understand loan level information, and thus better evaluate the risk position of a possible purchase and investment in the CMBS pool.  (See my earlier posting on the CMBS investor's perspective on loan-level transparency.)  This will facilitate the marketability, trading or liquidity of the CMBS bonds, which in turn will "unlock" the CMBS market and encourage CMBS 2.0 to be launched, so that Main Street will have the much-needed capital source of Wall Street.

It makes sense.

Indeed, capitalism depends upon information, and one benefit of technology is that we can collect it and share it.  So, let's share it.

And it makes "political" sense (in an election year).

But the effect of this will be significant.

Here are my current thoughts:

• Data Standards:  collecting and sharing data among all parties to a mortgage loan is NOT a new concept.  The MBA formed the Mortgage Industry Standards Maintenance Organization (MISMO) years ago in order to facilitate sharing information in a data format, so that one computer could convey information to another - without human intervention (this is called "B2B communication").  Note that when one working group heard of the proposed SEC rule, it was called a "tectonic event" and a "tsunami" - and for good reason.  (Winstead is a member of MISMO since it is important to our on-line information service that I briefly describe below)
• This Will Change CRE - the Halo Effect: clearly, CMBS 1.0 showed us that the CMBS product did influence other CRE finance products, and we're still seeing CMBS influence those products.  For example, the wealth of information reported from the current CMBS pools has people complaining about the lack of information on bank loans and life insurance company loans.  Well, if this rule passes - and my bet is that it will pass - these complaints might not continue. Yes, CMBS has a "halo effect" in that it influences the entire market.  This data collection requirement will effect the entire CRE market.
• Private Information No More: One change will be that private will be the new public.  This means that . . . .
• Private Is the new Public:  Let's admit something - brokers already know the terms of leases in the market, and they share it with each other and with their customers.  Right? I've seen a stunning presentation of the terms of commercial lease terms covering the entire downtown of Dallas.  But why should I be surprised?  Is there really a legally protected commercial expectation of privacy?  Do leases and mortgage loan documents expressly prohibit one party from sharing contract information with others, or even with an entire market (or the public)? Will this prompt parties to add provisions prohibiting this sharing in future leases and mortgages? But will landlords and owners "fight" this request, because adding this will reduce the marketability and value of the building?  This proposed rule could really start all kinds of reactions.
• Portfolio Loans Designed To Be Securitized: Here's a new thought - even if your lending product will NOT be securitized, IF there is any chance that you will want to do so in the future, then you need to collect this data.  Portfolio loans no longer are an inland to themselves - if the lender wants to kick the loan off the island.
• Workouts and Loans to Facilitate Sales:  And the same concepts and comments apply to workouts and loans made to buyers of REO: if there is any intent or possibility that the loan will be put in a private or public CMBS pool, then information needs to be collected as data.
• Collecting Data From All Participants: one obvious result is that lender will require that vendors (title companies, appraisers, surveyors, inspectors, lawyers, etc.) furnish relevant information in a data format.  No more e-mails with "hard copy" attachments.  Instead, the vendor will be required to furnish information in a usable format - which means as data in a database.
• Role of Lawyers: this change really excites me.  I've been noodling around with - even creating- databases on all sorts of topics (lease reviews; survey reviews; entity reviews; etc.) for years, but clients simply did not have a pressing need for legal information as data.  Except in one area: risk management.  We have an on-line service that one client uses.  I'll be discussing it (maybe even doing a demo) at the MBA Loan Servicing & Technology Conference this month.  I hope to see you at the conference.
• Costly Change:  change is NOT free.  This will impose an additional cost to everyone in the data generating-sharing chain.
• Tsunami Change: I agree with those who call this rule a HUGE change for the CRE industry.  The all-important political winds are in place to push this long-anticipated change into reality.

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

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In an earlier posting on CRE finance reform and market trends, I stepped back and asked the all-important questions:

• What does all this mean?
• What is the big-picture?
• Where is this going?

I offered up four perspectives, with these as the first two –

1. The Good: the “return” of the unregulated lender

2. The Bad: "extend and pretend” will continue due to more and more CRE defaults.

My third perspective is much more controversial, and probably will not receive explicit recognition nor acknowledgment by many:

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. Challenges from the investment grade bondholder include: (i) loan level transparency, (ii) structural concerns for CMBS 2.0, and (iii) finding an effective forum to effectuate these changes.

These are just some of the challenges facing CMBS 2.0, framed from the perspective of one of two of the most important players in the CMBS structure - an imaginary or hypothetical investment grade bondholder.

From this Investment Grade Bondholder: without this player, there is no market for CMBS bonds. This player is the most “under represented” player in the CMBS industry.  Here are some questions crafted with the voice of this hypothetical investor, as the industry heralds the arrival of CMBS 2.0:

• LOAN LEVEL TRANSPARENCY: Will CMBS 2.0 offer “real” loan or property level transparency, such as disclosure of modification terms for loans in special servicing; or rent rolls and operating statements for performing loans?
  • Servicers tell us that the Investor Reporting Package (IRP) [download guide; download version 5] contains information sufficient to our needs; will you tell this to our accountants and make them go away; and to the SEC as it seeks more transparency from us in our reporting? (This is all about information . . . data that we need.)
  • Speaking of the SEC, have you seen the proposed SEC rule [download a summary] that will require the disclosure of specific loan-level data, at securitization and then during the life of the pool?  Does the scope of the proposed rule address our needs? We're going to look into this . . . . (In a future posting, I'll cover the struggle between the servicers and the investment grade bondholders over loan level disclosures, which now comes under public scrutiny with the SEC's proposed rule.  The proposed SEC rule is called a "tectonic event" and a "tsunami" by a group working on industry-wide data standards.)
  • Who were the investment grade bondholders on the IRP committee that created this report?
  • Does the IRP “match up” with the pooling and servicing agreement provisions covered by my bond? (Did the attorney that drafted the PSA conform it to the IRP? We’re gong to look into this . . . .)
  • We understand that CMBS loan servicers report that loan level transparency (such as giving us current rent rolls) has legal hurdles relating to privacy rights of the CMBS borrower; so, where is the legal “white” paper that shows commercial parties have implied rights of privacy; or is it really a financial concern on the part of the loan servicers? Do the mortgage documents really prohibit disclosure?
• SIMPLE CMBS 2.0 STRUCTURE (?):
  • As to pools with multi-borrower loans, will these pools be the simple structures seen by us in the CMBS pools that were closed in the 4^th quarter of 2009? (Simple gives us both transparency and structures that address our special servicing concerns.  "Simple" does NOT look like this: download (depiction of a fairly typical debt structure from the "old" CMBS model).
  • Will we have information from, and the ability to influence, the special servicer in its decisions? What will assure us that the special servicer truly is making independent decisions in multi-borrower pools?
  • Who will be paying the rating agency fees; and how will the rating agency be equipped to monitor the pool going after securitization; and what will the rating agency reform look like? (Take a look at our white paper for our bottom line on rating agency reform.)
• FORUM FOR CHANGE(?): if we become active in the Investment-Grade Bondholders Forum with the CRE Finance Council, will this really be the best forum for us to champion loan level transparency, and where our comments relating to CMBS 2.0 structure will be given due consideration?  If not at this Forum, then where?

These are tough questions.

• What questions am I missing from this imaginary or hypothetical investment grade bondholder?

As we envision CMBS 2.0, this is at least one elephant in the room.

If you have comments or observations, or your own questions, please post a comment     

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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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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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(When we attend industry conferences, we bring you along by blogging on topics of interest to us, with our comments of course. This is the second in a series of posting relating to, and from, the 2010 CMSA January Conference. [Link to first posting] 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].)

It has been a very interesting day. The first session started at 11a and ended at 5:30p. As you'll note below, the sessions covered a wide range of topics: from "how" investors may find loan level information to an update on financial reform from a US Senator.

Here are the highlights (with some commentary, of course).

CMSA INVESTOR REPORTING PACKAGE ("IRP") COMMITTEE

This committee works on the reporting package furnished by loan servicers to CMBS bond holders. With the onset of this horrible CRE market, the bond holders have been complaining that the loan servicers are NOT giving them sufficient loan level information in the IRP. The IRP Committee is tasked to work on establishing best standards for the IRP. Consequently, it is an important committee, but appears to be stuck between the bond holders (who demand more information in the IRP) and the loan servicers (who anticipate changes in the CMBS model, and do not want to incur the costs of implementing new IRP content).  Hopefully, in the near future, the CMSA's new "Forums" will give them much needed guidance for this important work.

With this background, here are the high lights of the IRP Committee meeting: 

• the Committee has a working draft of an "Introductory Guide to the CMSA Investor Reporting Package (CMSA IRP), which will be posted on the CMSA website in the next 3-4 weeks. This guide is intended to help bond holders locate information. (Comment: It should be helpful. However, bond holders are seeking information outside of the scope of the IRP.)
• the Committee is working on standards for disclosing indebtedness of borrower or of its owners (other than the first lien mortgage created for the benefit of the CMBS pool).
• the Committee is forming a task force to indentify information required to be part of the IRP (pursuant to the typical Pooling and Servicing Agreement) but currently is NOT part of the IRP (Comment: if you're a bond holder wanting more loan level information, then I suggest that you contact the CMSA and join this task force).

Note that the Committee appears to be on a brief hiatus, as it takes a pause pending guidance from the two member "Forums" described below.

NEW "FORUMS"

In order to facilitate better communication within the CMSA between the various business interests, the CMSA is creating "forums." The Forums are intended to educate Forum members on topics important to the Forum, and also to advocate for the particular business interest within the CMSA, the larger industry and the larger political process. (Comment: this is a very, very wise move by the CMSA. It should avoid what some call "tranche warfare," which is where the senior bond holders assert that the special servicer is NOT taking action for the benefit of ALL classes of bond holders.)

INVESTMENT GRADE BOND HOLDERS FORUM

Three examples were given of "where" the investment grade bond holder would benefit from a "forum" process that would focus on the following –

• New investor-friendly practices for newly created CMBS issuances, such as these: out of money interest accrual should not prime principal; special servicing decisions must employ market rates of return; change of control should be based on realized losses plus appraisal reduction amounts; and much better loan-level disclosure can be delivered and are needed.
• Loan resolution practices by special services, such as these: loan resolution policies and servicer reporting procedures that are in the best interest of investment grade bond holders (such as data transfers); what are special services doing, and why; and how can loan resolution practices of investment grade bond holders be implemented for legacy CMBS (Comment: one special servicer noted that his company has extended over 97% of all loan maturities. Thus, creating what he called an "extension pile-up.")
• Selling REO with financing from the REMIC Trust, such as these: special servicers and the Real Estate Roundtable are advocating this before the US Treasury, without input by the investment grade bond holder; and could this change existing pooling and servicing agreements

SERVICERS FORUM

The following was articulated as challenges facing CMBS loan servicers: 

• Change from high growth (legacy CMBS model) to shrinking portfolios (in the absence of legacy CMBS model)
• The impact of the current credit environment on special servicing operations (Comment: one servicer noted that they have extended @ 50% of loan maturity defaults if the borrower presents a viable plan.)
• Address investor demands for more information and transparency. (Comment: pooling and servicing agreement requirements need to be examined, including sharing resolution business plans with investors.)
• Future growth opportunities and challenges (Comment: one loan servicer commented that CMBS would NOT drive growth during the next 12-36 months.)
• New servicing business models (Comment: one loan servicer commented that the "new" CMBS [referred to as "CMBS 2.0"] would look like loan syndications.)
• Similarities and differences of different investors

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 survery 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)

In my next posting, I'll cover the session titled "Lessons From CMBS 1.0: The Wonder Years" and then summarize some interesing comments made to us by Senator Bob Corker (R-Tenn), who is a member of the Senate Banking Committee.

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

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