The Commercial Mortgage Securities Association (CMSA) held its 13th annual convention in New York last week. Outgoing CMSA President Kent Born opened the meeting by recalling a comment he made at CMSA's January meeting in Florida. At that time, Born anticipated that, at some point, the CMBS market would likely experience some dislocation, but he didn't see it happening over the next year. He had a view of healthy issuance and stable spreads. This outlook lasted for all of about seven weeks, he quipped, given the dislocation that has occurred in the CMBS market brought on by the subprime meltdown. However, he said that he was still hopeful that the end result would be a stronger and more sustainable market going forward.
With this opening, the conference kicked off with a panel discussion on whether there is a "gatekeeper" for the CMBS market, who it is, and how effective it has been. The discussion included audience "participation" through handheld PDAs that recorded results to prepared questions, which helped direct the discussion. Based on the first survey question, 10% of the audience were triple-A investors, 12% were investment-grade investors, 21% were high-yield investors, and 57% were originators/dealers.
The audience was asked who they felt was responsible for playing the gatekeeper. Audience response indicated that 33% thought it was the B-piece player, 30% believed it was the rating agencies, 24% felt it should be all investors, while a small percentage said it should the loan originators or investment bankers/dealers. This question kicked off the panel discussion in which a panelist said that B-piece investors are buying only a small part of the structure and thus had limited pricing power. However, these buyers do shape CMBS pools, partly through their control over loan kick-outs and their discretion on whether to allow originators to add loans later.
Meanwhile, Kim Diamond, a managing director at Standard & Poor's, said that the rating agency's role was to be consistent and transparent, and to issue opinions that level the playing field. Rating agency analysis of CMBS deals is important for helping investors make important investment decisions, Diamond said. Still, she felt that there was no single gatekeeper and that all parties were invested in ensuring the viability of the market.
The investors in the panel noted that, with the increase in liquidity in the past few years, there has been a decline in credit. They felt the gatekeepers had lowered their investment standards, and Wall Street took advantage of this. One of the panelists noted too that, unlike in CDOs, the controlling class in CMBS is at the bottom of the capital structure.
The discussion then moved on to which lending practices will most likely lead to higher defaults. The audience was queried on this, and half selected "including future rent growth in underwriting NOI." The second highest, 27%, said it was overly aggressive valuations. Certain members of the panel aired worries about balloon loans and IOs in CMBS transactions. Some were concerned that when it came time to refinance the balloon loans, borrowers might have a difficult time. They suggested that this will not be a problem for a couple of years. Many assets in deals also had "transitional" issues and lacked cash management. S&P's Diamond said that the agency reviews about 60% of the loans in a pool - but did look at the "story" to see if there was validity, and also looked at cap rates.
So what has led to the aggressive underwriting of recent years? In response, 47% of the audience said it was competition from originators, 22% cited increasing fast-money/hedge fund participation, and 20% said the growth of the CDO market. Panel members noted that mortgage brokers were playing lenders. In addition, many loans would likely not have been made if originators held onto them.
The majority of the audience - 79% - believed that recent volatility in the CMBS market and increased focus on lending practices is a healthy wake-up call for the industry. Meanwhile, panelists said that if not for the subprime meltdown, it would likely be the "same-old, same old." While subprime has opened the market's eyes, it is still too early to determine whether this remains just talk and the market becomes complacent again, or whether the market will instead start walking the walk and implement permanent changes. Some specific concerns noted were that master servicers were not equipped for transitional mortgages or pari-passu loans, particularly because these servicers are understaffed.
As an end to the discussion, the audience was asked about their views on pricing spreads based on the last conduit pricing that took place. The response was that 51% felt the pricing spread was fair on the 10-year triple-A super seniors. In terms of the triple-B class, 40% felt the pricing spread was on the rich side, while 37% said it was cheap.
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