View from the (departure lounge) bench
Stranded overnight at Dulles Airport in a snowstorm may not have been the ideal end to the CREF Finance Council January conference, but it left me plenty of time to contemplate the (other) memorable moments from this year’s January CREFC Conference. Here's my summary of the event. For a selection of slides from the event click here.
Rational Exuberance?
The mood at the CREFC January 2011 event was near giddy. CREFC’s events are attended heavily by Wall Street-oriented players; CMBS conduits, issuers, rating agencies, securities lawyers and bond investors. I've said it before... what a difference a year makes. Michael Heagerty, Newmark’s CFO, described the mood at last year’s conference as desperate to suicidal; in January 2010 conference speakers were predicting health would not return to the CMBS new issue-market for many years, if ever. This year’s CREFC participants seemed to be shifting their outlook from relief at having survived to fully-pumped and ready for action.
2011 Likely Lending Volumes
Banks: Larger banks have worked through or written down much of their CRE loan problems and are coming in to 2011 pushing for resolution of distressed loans now that the real estate markets are seen to have stabilized. As a result, banks are making noises about making new commercial real estate loans in 2011, maybe even making a construction loan here and there.
Life Companies: The life companies as an industry will increase volumes moderately in 2011 over 2010 levels of roughly $30 billion. Life Companies generally increased their production targets for the coming year, but will face a lot more competition in 2011.
Wall Street: CMBS loan production may exceed life company volumes in 2011. In 2010 the industry did about $11.6 billion of new CMBS issuance. However, in the first quarter of 2011 $11.3 +/- billion of CMBS are scheduled to come to market. Various industry estimates for the 2011 full year range from $30 to $60 billion of new CMBS issuance.
2011 Rates and Spreads
Rates: The conference saw a fairly universal prediction that long term interest rates will increase as the economy strengthens. If you want low rates, root for a double-dip recession. Some speakers felt that with a full-paced recovery we could see a 5.5% yield on the 10-year T-Bill within a year.
Spreads: Spreads are already down but might have 20 to 25 BP left to tighten. Many CMBS investors have AAA bonds that were valued not long ago at 70 cents on the dollar, now find these same CMB Securities are valued at 105 cents on the dollar. The managers in an investor’s CMBS department look like heroes even if they did nothing all year. Investors are hungry for new issues and the 20 or so conduits that are now in the market are chasing the few good loans in the market. The issuers are holding firm at making 4% to 5% in profit on each new issue brought to market. So spreads will only tighten if the bond buyers are more comfortable and strongly bid for the bonds.
Hot topic - CMBS 2.0 vs. a rebooting of CMBS 1.2
There was much talk at the conference about the attempt to totally re-write the rules of engagement for CMBS under Dodd-Frank, an effort labeled CMBS 2.0. Many felt that the crafting of new regulations is turning into a jump-ball where Big Banks have an unfair advantage. The players at either end of the CMBS process, at the front borrowers and mortgage bankers and at the back bond investors and B Piece buyers, feel strong-armed by the dominant issuers of CMBS.
Each of the Big Four Banks (Chase, Wells, Citibank and BofA) plus Goldman Sachs and Morgan Stanley has more lobbyists in DC than any single trade association. These banks are pushing for and likely to get new rules that will limit competition, protect their securitization profits and maximize their control of the process. For example, the CMBS bond investors question the banks pushing for a vertical slice retention policy (a slice of each level of security from AAA to first-loss) to meet the 5% risk retention required by Dodd-Frank. As an alternative, the bond-investors are calling for a return to the olden days of CMBS, say the 1999 to 2003 playbook - what people are calling CMBS 1.2, when there were strong B-Piece buyers who actually held the first-loss risk in the mortgage pools and actively kicked-out bad loans from the pools.
The banks have the balance sheet to meet the 5% retention requirements, which today basically means leaving in their securitization profits. With a vertical slice the Big Bank’s retained profits will not be at risk – if the first loss piece is say 4% of the pool, 5% of that 4% is only 0.2% - a negligible amount of the Big Bank’s securitization profits.
Other Dodd-Frank regulations favoring the Big Banks: (a) Loan buy-back requirements in the proposed loan originator’s reps and warranties. (b) Planned Regulation AB changes making it hard for loan servicers with smaller balance sheets to stay in the game.
Competitive Landscape
JP Morgan/Chase had a 50%+ market share of the CMBS new issue volume in 2010. Nothing speaks louder about the loss of competition than a single player achieving a 50%+ market share. The Big Four US Banks, a few European Banks plus Goldman Sachs and Morgan Stanley will dominate the new CMBS world. Many of the 20+ conduits who say they are in the market are really planning to feed loans into pools led by these few big players.
So is exuberance warranted? Does a middle seat in Economy look great after a night on a bench at Dulles Airport? You betcha.
