Fast money has been a large contributor to volatility in the CMBS market, said panelists at last week's Commercial Mortgage Securities Association conference in New York.
Despite increased participation by hedge funds, attendees at the meeting were split virtually down the middle about fast money's impact on their participation in triple-A CMBS.
The panelists on "Is Momentum Driving the Market?" expressed surprise at the audience response, noting that fast money's in-and-out style, versus buy and hold, could affect triple-A spreads. In a later question about where spreads are likely to be by year's end on the triple-A 10-year SS class, the audience said that fast money would likely keep spreads from tightening to less than 20 basis points or widening to more than 35 basis points. Helping to keep spreads from moving tighter were ongoing housing issues and underwriting issues. The majority of the audience expected spreads to be in the area of 21 to 30 basis points by year's end.
Panelists said that hedge funds were permanent players in CMBS - a key element in its growth - and that they wanted as much fast-money participation as possible, as well as volatility. They added that unlike corporate trading desks, CMBS trading desks are equipped to handle large sizes without much impact on the market.
In addition, the growth of CMBS within the Aggregate and MBS Indexes suggested that nontraditional players were likely to become more active in the sector. Currently not really participating, they said, were foreign governments and central banks. The panelists felt that government treasuries and central banks would have to diversify at some point, and that CMBS would be a recipient of some of these funds.
While the subprime scare has given the market a wake-up call, focus on credit underwriting hasn't changed much, according to a poll of the audience. A full 43% said their focus is the same as always, while 38% said they were doing some more credit work. Only 16% said they were doing a lot more.
Furthermore, despite various discussions at the CMSA conference, many expect (and fear) that the push for tighter underwriting standards will die down and the market will revert back to its old ways. In a separate panel, originators didn't see themselves necessarily as the "gatekeeper," but they acknowledged that anyone who wants to stay in business for the long haul has to maintain a good reputation. The rating agencies, however, could be an influence here.
As discussion on whether momentum is driving the market wound down, the audience was queried whether recent volatility would reduce issuance this year. Exactly 50% said that it would, but by less than 10%, which would still likely result in a record year for issuance. Conversely, 30% of the audience felt that volatility wouldn't reduce issuance and that more borrowers would come to the table. This was seen as good news for dealers and originators, as investors seem to be just pausing to figure out the market dislocation. Once they do, it's likely to be "full speed ahead."
One factor that could ease investor fears is that there are no rumors of anyone closing down, as has happened in subprime. Consolidation also doesn't seem likely at this time, in part because profits are still good. Originators have also responded by tightening their standards on classifying properties, originating IOs, and the like. An originators panel at the conference said that recent subprime issues and the increase in interest rates have reduced their business about 20%. But they expect the system will "reboot" in response to the higher rates and higher cap rates.
The adjustment period is typically 60 to 120 days, they said. So fewer loans will likely be made over this period. A pickup in floating-rate issuance versus fixed is also anticipated, in part because many "transition" loans appropriately have floating rates - although with aggressive underwriting, many were placed with fixed rates.
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