There are very few shops that will officially say they are out of the CMBS market. But I would be very skeptical about any shop that is on the bottom 10 of the CMA league table.

If I was a Borrower, I would only do a loan with a bank that actually has its own shelf right now. (In full disclosure, I work at one of those banks) I have just seen enough Borrower come to me to do deals because another shop strung them along and killed a deal without any explanation.

 

"I'd only do business with one of the top contributors," says one of the top contributors.

I'm poking fun - there's some merit to the league tables - I'll hop on the argument that it's especially prudent now for borrowers to gauge originators' parents' commitment to the CMBS business before apping a deal, and to the extent that the bookrunner and loan contributor league tables help you figure that out, then IronChef makes a point.

That being said, I think it's more reasonable to draw the line at $1BN in annual loan contributions based on '15 and then exclude potentially unreliable actors that fall above that mark, e.g. certain non-US banks with flighty balance sheets, the rationale being that I find it hard to envision a scenario where the hardcore non-BB conduit outfits like Starwood, Rialto, etc., that don't fall in the top 10, walk away from the CMBS business overnight once RR becomes the law.

That and the argument that if any other BBs besides the BNK1 trio had gotten internal approval to retain 5% vertical, one would think they'd have announced by now.

 

Yeah I haven't heard of any more guys closing shop since the few that closed during the first half of the year. My guess would be that the non-bank guys that also do balance sheet lending will pull back from conduit (RAIT, Starwood, Rialto, etc). That being said, right now CMBS pricing and credit is the most aggressive I've seen it in the 2+ years I've been in the biz. Everyone's playing catch-up from a bad first half and trying to waive everything through before the music stops. Goldman especially has really aggressive.

 

@Lizard Brain - Why do you think companies like Rialto and Starwood will shut down their CMBS conduit originations? Many non-bank CMBS originators are looking to set up their own shelf to get around risk retention. I think Ladder and Prudential's conduit team are looking into that.

 

Apologies - I got verbose and muddled the whole thing. Can be pared down to: "hard to envision a scenario where the hardcore non-BB conduit outfits like Starwood, Rialto, etc. walk away from the CMBS business"

I've heard similar chatter that guys like that are in a better position to do their own shelves

Pretty sure there was a CMA article a few months ago about Pru doing it

 
Best Response

Pricing of either plan currently is up in the air, because while BNK1 performed excellently, that securitization cannot yet be taken as the norm. There has only been one. In addition, no shop has yet to perform a horizontal risk retention securitization; though, it is likely that spreads will increase under this plan. As the number of B-Buyers dwindles, they have been gaining more strength anyways, even before the risk retention plans hit the front pages of the CMA.

While Starwood, Rialto, and LoanCore may find their own solutions to the new world of Risk Retention, there are many other considerations with going down the "buy your own B-Piece" (Jeffries) and the "make your own shelf" (Rialto, SocGen, Cantor). Here are the significant headwinds currently facing these new plans:

First, it takes many months to get that type of approval, so if they fail to have a plan in the works by now, they will likely not be able to have something in-place for the December 2016 deadline. Not a bad thing, but it does mean they start the year (2017) slightly behind.

Second, buying your own B-Piece works if you are willing to only securitize your own loans. While substantial in their own right, the shops mentioned do not securitize too often and rely on large shelves to carry their product to market (used to be primarily DB/WF). What will happen when Jeffries securitizes with other non-BB shops? Will Jeffries purchase the B-Piece on those loans too?

Third, to have our own shelf and securitize loans is a logical exit strategy, but Bond buyers (primarily BBB and up) like to have the ability for the bonds to be easily traded with the securitizing bank. While these smaller shops have these secondary trading desk capabilities, they lack the depth of a JPM, MS, GS, and BofA. While not the primary reason why these securitization performed poorly, we saw that Cantor and SocGen securitzations in the beginning of the year that faced this headwind (albeit among many others). I suspect bond buyers will likely demand a greater premium due to the (perceived or not) illiquidity.

With all that said, the CMBS market is a robust market nonetheless and as a result, will likely come up with a solution for these smaller players to continue to exist. Trust me there are an army of lawyers and quants in New York and elsewhere trying to figure a way to make these guys profitable. These shops serve a purpose in the risk spectrum and in the past have often performed on loans in admirable and new innovative ways. The CMBS market is far too important to the CRE world for new rules and regulations to undo it.

 
IronChef204:

With all that said, the CMBS market is a robust market nonetheless and as a result, will likely come up with a solution for these smaller players to continue to exist. Trust me there are an army of lawyers and quants in New York and elsewhere trying to figure a way to make these guys profitable. These shops serve a purpose in the risk spectrum and in the past have often performed on loans in admirable and new innovative ways. The CMBS market is far too important to the CRE world for new rules and regulations to undo it.

That's the thing that gives me the most comfort. There are a lot of very determined, very vested people interested in maintaining CMBS as a viable and healthy industry, and I think that includes a place for shops all along the loan-quality spectrum.

If anything, the tiering that people speculate might happen between bank-only consortium vertical deals and shadow-bank horizontal deals (if that's how it shakes out) may very well benefit most parties involved by providing more defined homes for different products and players, instead of the blurrier scrum we've generally had on a lot of deals. Maybe that's just glass-half-full optimism. Either way It'll be interesting to watch unfold in real time.

Big picture, it also helps to appreciate how much the industry has evolved from the prehistoric RTC days. CMBS has changed a lot in the last 25 years and will continue to morph. This is just the next level.

 

May be a dumb question but: what do you mean they have 'there own shelf?' Does that imply they have a business that originates loans, and a separate unit that acts as the investor into the bond full of said loans?

What I find hard to grasp is that if these bonds are full of 30-100 different loans, how can an investor perform any kind of substantial due diligence/underwriting on the underlying assets within a reasonable timeframe to close the deal? If I'm underwriting 50 deals, it's going to take a while, so how do these guys buy up dozens of bonds per quarter? I don't think they have armies of analysts...

 

Not a dumb question if you don't work in the wonderful world of CMBS. It's complicated and has a substantial amount of useless legalize, but somehow (in ways I don't fully understand) the shelf is the securitization platform. It allows larger banks to originate, store, and ultimately securitize the loans. Where as smaller shops require the use of a larger bank's shelf to securitize the loan.

As for your due diligence comment, there are often 30-100 loans in a pool with varying loan sizes, but the amount of due diligence performed differs from the AAA buyers all the way down to the B-Buyer.

The AAA bond buyer really only looks into the top 10-15 loans because they are what really effects them in the event things go bad. So they will read the banks' prospectus and the Rating Agency Presale Reports (basically how the Agency would underwrite the loan), generally that is Fitch and Moody's (though S&P gets thrown back into the mix every now and then). Reading 10-20 transactions is not insane; I literally do something like that every week. The way these bond buyers see it is that a small $9 million dollar loan going bad is not likely to protect the cash flows of a AAA bond since there is so much credit enhancement. The top ten loan notes are generally anywhere from $25-99 million in size. This is important because you often have larger loans that can be split into multiple loan notes and securitized over multiple securitizations, and now you often have notes from stand alone securitization loans to carry the rest of the pool. I am going to skip the AA and A buyers because they generally mimic the AAA buyer, but are also more of the hot money types. (So they may not necessarily do as much due diligence).

The B-Buyer, the guy who buys the non-investment grade portion of the trust (B-, BB-, and some of the BBB-), looks at every loan and often time do have an army of analysts (or they out source it). In addition, they will often times get an advance look at the loans, like the agencies. This is because they now act as the gate keepers to a securitization and can kick loans from a pool. B-Buyers are often the worst when you look at it from the originator and underwriters point of view, but in my opinion, they serve a very important purpose.

 

Hey now - BNY/Ironhound on the sidelines "until they see the full effects of RR" (riiiiight)

They obviously weren't conduit but FirstKey folded out of Cerberus and now has backing under a new name from an unidentified capital source. Symptomatic of the bridge lending space's problem with overcrowding proving suffocating? Too hard to make profitable deals so Cerberus wanted out of the business?

 

^^ Agreed. Regs are def a big reason that has pretty much everyone involved in CMBS (origination, securitization, buy-side, etc.) talking, and to an extent, concerned. Another few reasons in my mind are:

I) Cost of Capital: Picture one small conduit loan (~$5MM) getting 20+ term sheets at any point. The competition gets intense and really drives down spreads and hence profitability on these loans. This may not be that big of an issue for some of the larger lenders who generally tend to do larger deals anyway and have established repeat brwr relationships that partially mitigates them being wide a little vs. the competition. But is a cause of concern for some of the smaller lenders that have a higher cost of capital - at one point it wont make too much sense to stay in conduit lending.

II) Volatile Markets: Many lenders don't really have the kind of risk tolerance to bear the risk of spreads moving unfavorably - this is especially true for the 'LOC' lenders/ lenders without real balance sheets and this again ties into the first point about cost of capital. We have already seen a few lenders/JV make an exit due to lower than target returns.

III) Collateral differentiation within shelves: Think over the 2nd half of last year, bond buyers (in the new isuse market) have shown a preference for buying deals with more collateral from the larger lenders/BB, as well as smaller securitization sizes, leading to deals with collateral either all from 1 bank (e.g. GS1) or mostly from 1 lender (e.g. JP1). I am not sure if this trend is really here to stay but I do see the smaller lenders constantly trying to re-evaluate which shelve to be in (something that wasn't too prevalent a few years ago). I think this is partially due to collateral differentiation, and also due to the fact that conduit securitizations are MUCH smaller now (~$900MM) than what they were CMBS 1.0, meaning less collateral is needed to get to critical mass hence not a real need to have a lot of contributors to your pool.

Its also true that collateral quality will generally decline as we go further into the cycle, but there will always be players out there who will not 'work for less' (aka less profitability on loans) vs. others. I think this wont work for long because, at least for now the Agencies (i.e. Moodys ) as well as B-Buyers are, holding firm on Haircuts/CE and kickouts (more so for B-Buyers now that they will have to retain their bonds for longer), it means a higher probability that loans with loose structure and tighter spreads will turn out to be money losers.

Though this is all just my $0.02.

 

There will be a shake out of a lot of CMBS lenders, but the firms still offering conduit loans will be considerably smaller. The smaller shops just do not make enough loans for the shake out to matter. Borrowers are fed up with the lack of rate clarity up front, long lockout periods, expensive prepayment options, and the terrible servicing that some handful of banks offer (There is one big one that everyone hates). In addition to that, the cost of capital for a conduit loan is getting so expensive that the extra leverage is no longer worth the interest rate when compared to lower leverage options from banks and life insurance companies. This should call into question the saneness and profitability of those portfolio lenders. In a rising interest environment, why would a Lender be willing to lend out at interest rates that are so incredibly low for such lengths of time. Nevertheless, today's Borrowers have forgotten how low the interest rate is when compared to the historical average. Is 5.0% money really that expensive? It only is if you're paying a 5.0% cap on some retail center in fly over America. Trust me, there are plenty of people who are paying those insane cap rates; I have a pile of OM's on my desk asking for money to do just that.

These new rules and regulations that are being imposed by the government on lenders is only going to make it more difficult if the smart people at the investment banks, expensive law firms, and funds cannot find a way to appropriately deal with them. I can assure you there are an army of very expensive "smart" people who are figuring ways to balance and risk. B-Piece Buyers, Rating Agencies, and ultimately Bond Buyers are becoming appropriately conservative because the stuff coming to the market is so aggressively underwritten and the collateral is the 2006/2007/2008 stuff that is just awful. I see my competitors underwrite these loans like Brokers. The question for today's borrower is whether or not they need the extra money of CMBS and if so, do they want to use a finance company that will not be there at the closing table (with terms or even exist at all) or do they want to use a bulge bracket bank with an enormous balance sheet.

All in all, there needs to be a market clearing of the many market participants who have no idea how to underwrite loans and ultimately bonds that are going to last for five, seven, and ten years, and the overall market turmoil isn't helping either.

 

That's absolutely true, although a 30-40% reduction is extreme, I doubt it. Already Walker & Dunlop exited the business, Guggenheim's joint venture was killed, and probably more coming.

You could see, as a result of risk retention, a "vicious cycle" where CMBS can only compete on inferior-quality loans because of the higher loan spreads, which in turn requires higher credit enhancement and wider bond spreads, which in turn raises the cost of funding, passed onto the borrowers, etc.

CMBS's outlook is pretty bleak right now. I work for a CMBS investor and even I'm questioning the viability of this. CMBS really needs a consistent product - and if we go through this underwriting cycle every 6 years or so, that's not going to happen. Brings up deeper questions - is commercial real estate too idiosyncratic and risky to be commodotized into a pooled bond? Can CMBS ever yield enough, and have enough credit protection, to be a sufficient and reliable real estate exposure for any given investor?

Residential MBS works for a reason. The homogeneity, predictability, and the commodification of it. A lot of investors who are in this CMBS game may be better served changing their real estate exposures to direct lending, participations, REIT ownership, or equity/development. The overhead and expense for this, in terms of due diligence, is greater, but today the game has changed and I think more investors are treating real estate and alternative assets as a core holding, eschewing corporate fixed income and stock equity.

 

You make a lot of good points and I agree that CRE might not be the best asset class to be pooled into bonds. The President of my company makes an interesting argument about the market for CMBS deals. Essentially, he believes that there will be Life Co. business, low to high leverage, well occupied and cash flowing properties that are basically slam-dunk deals (with the occasional exception). Next, and very similar to Life Co. business, will be the Agencies who will be slightly more aggressive than the Life Cos. on the Multi-Family and Student Housing Front.

Lastly, there will be the CMBS market, which will be the highly leveraged, hairy deals, where Borrowers pretty much understand that Wall Street is the only way to go (and willing to pay the outrageous Legal Costs, etc.). All in all, there will be a home for every deal and he thinks that is the way it should be all the time. He absolutely hated 2014, because conduits were competing on the same deals as Life Cos.

 

CMBS is only going through a lot of turmoil at this point because there is so much uncertainty in the market place. Macro events are exacerbating the complex new rules and regulations. The entire reason why CMBS exists is to spread risk around, and even while the B-Piece retention is going to make things different, it is not as if these B-Piece buyers were constantly trading their pieces to begin with. In addition to that, CMBS is only becoming less viable because portfolio lenders are becoming more aggressive. In my opinion, for no reason at all other than the fact they can. The collateral they are bidding on and the dollars they are providing are beginning to make them to start looking like CMBS lenders. When these conservative lenders snap to their senses, CMBS should be there to plug the gaps.

I personally think the burden should be put on the B-Piece Buyers, traditional bond buyers, and Agencies to actually do their own due diligence. These guys shouldn't really be reading a Presale and an offering term sheet to judge a pool; most guys should really be doing a lot more due diligence. There are maybe a hundred loans in a trust, not ten thousand. There are some shops that just write loans with their eyes closed, and they should be punished by the entire capital stack, including the AAA guys. If you look at the last six to seven months, for the most part, the benchmark AAA's really have moved in lockstep. There is not that much differentiation between the CMBS shelves.

And the returns on a CMBS AAA is pretty good when you think about it. If you really think about it, the benchmark ten year super seniors are really the equivalent to a life insurance company portfolio given that they really represent something like 50% LTV on the underlying assets anyways. So much of the pool has to be a loss for them to take a hit. If anything, if I were an investor in a portfolio lender, life insurance company or bank, I would be furious that loans are being written with interest rates that are so low. Then the loans stay on the balance sheet for ten, twelve, fifteen, twenty, and hell I have seen thirty years because no rational property owner would refinance that loan.

Lastly, the B-Piece guys are plenty compensated. If you look at the returns of the B-Piece buyers, their yields are something in the nature of the high teens, soon to be low twenties. Many mezz guys do not even get that type of return.

Hopefully when things calm down in the market (real estate and macro markets) as a whole, CMBS will be more reasonable, but it is still a very much viable business.

 

I'm not too worried about loans refinancing - there will be maturity defaults, but with the amount of price appreciation currently, a lot of loans that were thought to be underwater have recovered. It's more the CMBS market itself that is at risk. This isn't really a real estate issue, despite us discussing this here - it's more of a fixed income / trading issue. On this point, I think portfolio lending is as healthy as it can be - capital will continue to thrive there, as long as underwriting remains prudent.

Just this week we have had a new casualty - Redwood Commercial Mortgage Trust just exited CMBS lending.

 

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