Confronting the CMBS problem

Everyone I talk to says the key to real estate market recovery is resuscitating the CMBS markets. There’s plenty of equity “on the sidelines,” but without credit and refinancing sources, the capital markets will stay frozen. Ironically, the CMBS concept helped jump start market recovery 15 years ago, bringing new sources of capital into property sectors when banks and insurance companies were reeling from a prodigious round of poor-underwriting induced red ink. Now the moribund CMBS market hamstrings prospects for a near-term turnaround.

A year after TARP was enacted, the U.S. Treasury Department finally puts in place a scaled down program to help banks unload troubled mortgage securities. The Feds will match investments and provide a credit facility for big investment banks and their clients to buy problematic CMBS at significant discounts.  Of course, this is another classic case of the guys who engineered the mess with all their structured finance and reaped huge fees along the way, now getting taxpayer assistance to make more money with low risk in cleaning up the problems they helped create.

The government initiative—called the Public-Private Investment Program (PPIP)-- effectively provides matches and guarantees that will generate about $12 billion in troubled asset purchases—mortgages and CMBS--by private investors, about half the money coming from taxpayers. Well, it’s a small start at least, considering that worldwide financial institutions have about $3 trillion of bad mortgages and CMBS on their books. In the U.S. about $50 billion in CMBS loans mature in each of the next five years and will need to be refinanced. Many of these loans are or will be in technical default because properties have lost so much value.

Of course, the hope is PPIP will help markets identify a pricing floor and unfreeze the transaction universe so more bad assets can be moved off financial company books. Once that happens, the game of hope and pretend will be over--borrowers, lenders and owners who have been putting off their day of reckoning must finally recognize the extent of their losses.

Whether PPIP works or not, time inexorably moves markets closer to finding bottom. More borrowers will start giving back underwater properties since the lack of tenant demand savages cash flows and makes it ridiculous to keep servicing debt. The FDIC will step up assets sales from portfolios of failed banks it has taken over.

But then government regulators, bankers, and ratings agencies must figure out a system for restoring confidence to bond buyers so they have some idea what they are investing in when they buy CMBS. Self regulation--ha, ha—certainly didn’t work. And it makes no sense for offering sponsors to pay rating agencies for their imprimaturs. Nobody wants to deal with these thorny issues. And in the meantime, lawyers, special servicers and bond holders steer clear of confronting the bugaboo of who owns what and what it is worth in the ball of confusion of existing CMBS.

If recovery depends on the CMBS markets, we have a long ways to go.   

Comments

[aupanner]

The CMBS model is dead - for now. Like a dormant seed of grass. For now, for real investors, the thought of buying a black pool of fixed income securities is unthinkable. For now, money is again being "invested". Before, it was being allocated.

A version of the CMBS market should come back soon - whereby the issuer keeps the bottom 10% of the paper and is the manager/servicer. A few REITs can execute that model. But that's how MBS paper should get put to market now.

Later, when market liquidity becomes excessive again and fund managers become allocaters again, with the right mix of water, sunlight and shade, the seed will begin to grow again.

And then of course, it'll get squashed...

[Dark Space]

The entire commercial mortgage market is $3.4 trillion - are you saying that $3 trillion of it is bad?

Also, there is http://thecrereview.blogspot.com/2009/09/assessment.html

To aupanner's comment, the special already hold's the bottom of the CMBS stack. Some ABS issuers have pfandebriefe like structures too. We may see this, but this doesn't eliminate or solve any problems - the issuer just values the residual piece at zero and we're back at square one.

Technical Default? U.S. CMBS loans do not have covenants that cause them to go into technical default because the underlying asset value goes down.

[Dark Space]

For some reason it automatically abbreviated my comment (above). The second paragraph said something to the effect that the maturity schedule in CMBS over the next 5 years is below $50 billion each year, and most of those bonds are 10-year old bonds, with higher coupons than today's going rate, 10-years of appreciation, lower LTVs - they won't have the issues refinancing that a lot of non-CMBS debt will have.

[aupanner]

"10-yrs of appreciation"?
I think that the appreciation is negative in most markets on this planet.

DS - I think you're probably correct with your comment about being back at square one if assets fall. I was making the assumption that the bubble would be less likely to form in the first place, if lenders were actually lending their own money. But, since it is always going to be a volume business from our (employees) perspective, it's tough (impossible?) to take remove the temptation to over-lend.

I wonder how the compensation structures will change coming out of this, if at all. It's probably more likely that people just bounce around and get a new "basis" at a new platform. It's almost like track record doesn't matter because everyone's is so bad and if yours is good, then it is viewed as luck.