The multitude of Dodd-Frank regulators are working on the new rules for CMBS 2.0. Built into the Dodd-Frank legislation is the concept of a Qualified Commercial Mortgage (QCM) - a mortgage considered conservative enough that no risk retention (aka Skin in the Game) will be required. QCM Pools will have different players, different subordination levels and better pricing than CMBS bonds made up of loans that do not qualify as Qualified Commercial Mortgages.
I would like Congress and the Regulators to look at the QCM issue from 30,000 feet. If they do, I am hoping they will agree with me that creating two classes of CMBS will cause more harm than good.
What is being proposed are two classes of CMBS “Prime” and “Less than Prime.” (Let's not use the phrase "Sub-Prime")
You may feel a sense of déjà vu: We saw this before in residential.
Two classes of CMBS is a mistake for three reasons:
1. It is not good for commercial real estate.
2. It is not good for portfolio lenders.
3. It is not good for the CMBS industry.
Let me take these in order:
1. Threat to Commercial Real Estate
Quality commercial real estate is not suffering from a lack of capital. Quite the contrary, we are hearing the word “Bubble” being thrown around again. Life Companies are slugging it out to win the conservative loan business. What is lacking is capital for properties that, for reasons of location, product type or leverage, are not targeted by the portfolio lending industry. This is why we need CMBS to come back. QCM pools are a distraction for the CMBS industry. Creating a “Less than Prime” second category of CMBS will discourage funds flowing to where it is desperately needed. And when these funds do flow it will increase the cost of borrowing for owners of real estate largely ignored by the portfolio lending industry
2. Threat to Portfolio Lenders
When Ronald Regan was in office there were two classes of commercial real estate and commercial loans; life insurance quality deals, and S&L Quality Deals. Things have not changed. The life insurance companies are lending on the same quality deals. CMBS came in in the 1990's to fill the void the S&L's left. Having the CMBS industry now target Life Company quality business with a source of very cheap capital is an unneeded threat to a vital portfolio lending industry. A low cost of capital killed the residential portfolio lending industry and could do so again in commercial lending.
3. Threat to the CMBS Industry
What we had in CMBS 1.0 was pretty much an undifferentiated securities product, with mortgage pools containing both the diamonds and the dreck. Removing the diamonds will not make for better mortgage pools. This new two tier CMBS system is not in the interest of the bond investors. The QCM pools will lack risk retention and will be created with very high incentives to force deals to be qualified as QCM. Subordination levels on QCM pools will be minuscule. I think that time will show that QCM pools will be anything but risk-less.
CMBS bonds made for Less than Prime pools will be penalized in pricing: By removing the diamonds from the dreck the cost of mortgage loans for non-QCM product will be high and financing for this class of property might not be very plentiful.
