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Uncertainty Killing The Recovery in CMBS

June 2, 2009

There’s a Fortune article featured today discussing Standard and Poor’s (S&P) decision to review it’s ratings on CMBS debt.

The flap started last Tuesday, when S&P said it was considering changes in how it rates CMBS. The New York-based unit of McGraw-Hill (MHP: 0.00 N/A)¬†warned that the changes could result in downgrades of a large number of recent-vintage issues — including 90% of the most-senior notes issued in 2007, the peak year for commercial mortgage securities issuance.

S&P, Moody’s, and Fitch were all part of the problem that led us down the road we’re on. Slapping AAA ratings on things which should have been far from AAA led to the mistrust that is roiling the markets today. Now, many are concerned that the pendulum has swung too far in the other direction.

The problem is that S&P is injecting further uncertainty into the market when it prematurely “notifies” the market what it is considering doing. It raises concern and doubt, and thereby delays the very much needed washout and recovery of the CMBS market. Investors are going to continue to sit on the sidelines so long as the risk of a downgrade looms, since the underlying price of the securities are directly rated to the rating.

At this point, I think S&P just needs to make the cuts and get it over with.

The other issue of course is the government’s efforts to get the market liquid again. If the agencies cuts the ratings, many of these assets might no longer be eligible for TALF. Some are complaining about this, but to me this is of less concern to since taxpayers are helping foot the bill, and it is better we are not sold a bill of goods for a second time.

Read the full article here.

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Categories: Commercial Finance and Lending | Trends
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Comments
george gellman June 4, 2009


There is a simple solution to the long term liquidity problem in commercial real estate and it will not cost the Government a dime. For decades, Fannie Mae (its other problems notwithstanding) has run a simple and highly successful insurance program to provide long term mortgages for apartment projects. A designated underwriter, such as Wells Fargo, brings a transaction to Fannnie Mae and Fannie Mae guarantees the mortgage loan for an annual insurance premium. The underwriter also guarantees a portion of the loan and receives a portion of the insurance premium commensurate with its guarantee. This is a key component of the program because unlike the programs that caused the housing meltdown the underwriter of the loan has “skin in the game” and stands to suffer a tremendous loss if its underwriting is at fault. The insurance premium is set to cover any losses as well as administrative costs. The program has been and continues to be a great success for everyone involved: the developer, the underwriter, the Government and the pension fund or other entity that purchases the mortgage. There is no reason why the same concept could not be applied to commercial real estate loans having the FDIC or other Government agency assume the role of Fannie Mae.

squarefeet June 5, 2009


George – thanks for the comment.

I agree that having “skin in the game” really is a big part of the solution. What did the system in was the assumption that one party would responsibly invest the assets of another if their income was tied to fees generated by the investing (in this case origination, securitization, and selling) and not the outcome.

If the party originating and securitizing wishes to sell the asset, one solution might be to force them to hold on to the junior piece. Of course, what this means for investors is that even if the MBS market comes back, the lending standards will continue to be stringent, which ultimately puts all those who acquired an asset using funny money underwater for well into the foreseeable future.

Froggy June 10, 2009


George,

The problem going forward is not only the financing mechanisms (which are essentially gone) but the asset fundamentals and market cap rates. There is no “skin” left to have in the game. The CMBS market needs to implode so that these unserviceable loans can be bought for pennies on the dollar and ownership gets bounced. That way the new owners can actually write leases that tenants can afford and reduce the tax burdens on the assets.

How much of the vacancy rates are landlords who can’t lease at the current market rate because it would lock in their inability to service their existing debt? It all starts with deleveraging these deals and getting tenants (new business & employment) going. That cannot happen while these assets sit there underwater.

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