CREFC 2015: What Worries the CRE Finance Industry

We sat in on a number of panels at the event this week, and while rising prices and CMBS volume, in combination with low CMBS delinquency, were rightly cause for celebration in the CRE finance community, there were a number of issues still on the minds of the professionals in attendance.

Among the concerns: a need for increased transparency in bonds backed by real estate loans, the fate of non-Gateway markets, risk retention, “edgy” underwriting and the erosion of appraisal standards.

At a panel called “Investor Perspective: Foot on the Gas or Step on the Brakes?” panelists admitted that even post 2008 financial meltdown, it’s still hard for investors to see all the assets backing many loans in securitized products. A major B-piece buyer cautioned that many investors think if they see the biggest 10 or 15 loans in a repackaging, they’ve done their due diligence. But this is not the case, he said.

Of particular interest are packaged mezzanine loans, according to another executive. “We need way more transparency for mezz bonds,” he said. The B-piece buyer suggested that more tiering in securitized loans would help assuage undue risks for investors.

Of course, not everyone in the industry is incentivized to want transparency. Demand for non-recourse, high leverage loans can push borrower and issuer alike to close loans quickly and less carefully.

“CMBS loans don’t happen in a vacuum,” offered one executive at a massive investment manager, hinting that issuers and borrowers simply want to get deals done, often—perhaps even at the expense of transparency.

And deals are getting done. CMBS issuance reached over $90 billion in 2014, according to CREFC estimates, and players in the securitization space admitted that the real estate industry’s lobbying on behalf of the CMBS business has been very successful.

“The business operates exactly as it did in 1.0,” the B-piece buyer said. (“1.0” refers to the wave of CMBS issuance pre-financial crash).

Still, investors are worried about vintage losses from deals completed in 2006 to 2007, as well as risk retention.

“There are losses that could break into the double digits,” said a principal with a hedge fund.

One managing partner with an investor in CMBS debt added that his firm has learned one lesson from the 2008 fiasco: not to lend on assets outside tried and true markets.

“We would rather have higher leverage than an asset in Tallahassee,” he said.

The industry is also bracing itself for the onset of so-called “risk retention” rules, a provision of The Dodd–Frank Wall Street Reform and Consumer Protection Act that requires lenders to hold many loans on their books for five years after they’re originated. The provisions should take effect on December 24, 2016.

“It will make it hard to do price discovery,” one panelist said.

Others were less worried about the impending restrictions. “It will be a little inconvenient to figure out the rules of the road,” said the B-piece buyer, but as a whole, he said he did not believe that the CMBS business would be disrupted.

But he did point to another major worry, which should give any observer of the real estate industry over the last seven years pause: the erosion of appraisal standards. “You are seeing more bad appraisals. There is a grossing up of phantom cash flow,” he said, meaning that appraisers are sometimes taking a wildly optimistic view of the assets they assess. “People are trying to hit the magical LTV.”

His point dovetailed with that of a prominent banker at another panel, entitled “What is the New Normal in Balance Sheet Lending?” He said portfolio lenders found it hard to compete with CMBS lenders, and their book of business could shrink.

“People are saying ‘ok, I’ll go elsewhere,” when portfolio lenders can’t provide a non-recourse loan at 75 percent LTV, the lender said.

Indeed, the prevailing sentiment among portfolio lenders is simple, according to another banker on the panel: “we want to go back to 2010 and make all those loans again.”

Portfolio lenders agreed that either pricing or volume are likely to be compromised in 2015.

“There is a point where portfolio lenders will just say ‘we don’t want to play,’” he said. “Doing volume for volume’s sake is not a goal.”