NAPLES, Fla. - If only the current state of the commercial mortgage-backed securities market was as idyllic as southwest Florida in January.
Balmy weather, blue skies, palm trees, lush golf courses and consistent sunshine were the backdrop for this year's Fabozzi/Information Management Network Annual Winter Buy-Side Forum on Commercial Real Estate Finance and Securitization, held at the Registry Resort Hotel on the beach in Naples last week.
But in between golf strokes and tennis swings, the approximately 300 attendees discussed with some level of concern a maturing market that not only experienced a drop in U.S. volume of $20 billion in 1999, but was about to face many new challenges in the new millennium, including: the specter of e-commerce, the challenge of moving transactions and originations onto the Internet, an increase in floating-rate deals, a possible uptick in delinquencies, rising interest rates, a decline in demand from the real estate investment trust sector, and a splintering of the market brought on by CMBS players' growing allegiance to a competing industry group, the Commercial Mortgage Securities Association.
Two Conferences?
"This is indicative of what happens in volatile markets," said Fred Fellows, president of Cargan Investment Management, referring to this year's two competing CMBS conferences - the Fabozzi conference in Naples and the CMSA conference in Miami - which affected attendance levels here this year. "I find this quite frustrating, and I hope people in this market can work together better in the future. People in this market need to voice their opinions about how they want this market to go."
Indeed, participants were buzzing about the effects of having two simultaneous events. "There is a noticeable lack of rating agency representatives here," commented one CMBS player in Naples. "How can you have a CMBS conference without rating agency people? That's like having a wedding without a pastor."
The CMSA, a nonprofit trade organization, openly competed with industry veterans Frank J. Fabozzi, Inc. and Information Management Network this year when the former group scheduled the Miami conference on the same days as the Naples conference. While players tried to split their time between both events, many had to choose one over the other.
"Let me just say that Fabozzi has been a proponent of this market and a very positive influence on it for a long time, and that should not be forgotten," said Stephen L'Heureux, vice president of Boston-based AEW Capital Management.
Despite the issues overshadowing the proceedings, a generally upbeat view was expressed by market participants. An even stronger theme than the one of market unity was the "maturation" of the CMBS arena, reflected by the fact that investors, B-piece buyers and issuers have all begun to get set in their ways in regard to how they undertake and process transactions, as well as how they analyze them.
"We have reached an optimal efficiency level in sizing transactions," said Jerry Pietroforte, a principal at Deloitte & Touche. "There has been some consolidation in the U.S. in connection with fewer servicers and trustees. And there has been a trend of tiering, wherein the top three [issuers] counted for 43% of overall issuance [last year]."
Bullish Spread Picture For 2000
More importantly, Cargan's Fellows forecasted that during the next six months the CMBS industry will experience "the highest volatile ups and downs that we've seen in over four years."
The majority of attendees predicted a supply of approximately $50 billion to $55 billion of CMBS for 2000, though a few predicted as high as $60 billion or as low as $40 billion. In 1999, CMBS issuance totaled $65.2 billion. However, rising interest rates will probably limit 2000 volume considerably. Decreased issuance volume, however, should enable CMBS spreads to tighten in 2000.
"We saw some pretty wild spread moves last year," said Brian Baker, a vice president at J.P. Morgan & Co. "We had the overhang of the liquidity crisis last year, in addition to the Y2K bug concerns. But I think the market has somewhat improved its liquidity."
According to a report from Salomon Smith Barney, investors in single-A and triple-B-rated CMBS could benefit from a 30-basis-point to 50-basis-point tightening of spreads in these classes in 2000. Additionally, the Bond Market Association's application for Erisa relief, if granted, would further assist in flattening the credit curve.
Lehman Index, Erisa Eligibility
The inclusion of CMBS into the Lehman Index last July "brought in marginal money," Baker said, but ultimately did not have the impact for the industry that many players had predicted.
"I think the short-term effects on this inclusion were overstated, but the long-term effects have been understated," added Roger Lehman of Merrill Lynch. "It definitely raised the profile of CMBS among investors." Still, CMBS only represents a nearly negligible 1.47% of the Index.
Other topics discussed were the increasing tiering and branding in the CMBS market, changes in Erisa eligibility and the outlook for volatility.
In October, the Bond Market Association filed with the U.S. Department of Labor a request for Erisa-exemptive relief for several subordinate investment-grade asset-backed securities, including CMBS. "If successful in 2000, the application could provide a new investor base for double-A, single-A and triple-B certificates," said a Salomon report.
"I think the Erisa changes will be a big boost for the CMBS market," said Jim Titus, the director of real estate debt research at Donaldson, Lufkin & Jenrette Securities. Still, panelists were grappling with whether the Erisa changes were already priced into the market, and what would become of the interest-only (IO) market if the Erisa changes went through.
Overall, market participants concluded that the market was settling down a bit from previous years but no longer was an "emerging" asset class.
"The type of volatility we saw in 1998 is gone; we will not see that going forward," noted Patrick Corcoran of J.P. Morgan.
Brian Neilinger of CIBC World Markets - a self-described "conservative" bank that allocates $3.5 billion to debt capital and $1 billion to the conduit market - was bullish on the real estate market but compared the maturing CMBS market to a golf game, reflecting a larger trend on the Street.
"The tolerance for risk has been reduced by Wall Street," he said. "Four years ago, you had fat profits and fat bonuses. You don't have that anymore." Using a Tin Cup analogy, Neilinger said that a few years ago a CMBS player could afford to hit a ball into the water eight times in a row.
"But you just don't have that many balls in your bag anymore," he said.
