Commercial Real Estate Values to Decline by 30% to 50%
I have seen that headline a few times, but I never really believed it. I do now.
CMSA Europe Conference, Day 2: Not all negative
On Wednesday morning, my “happy” post-election emotion was replaced with a toxic combination of hangover and jet lag. I hit snooze a bunch of times and finally made it over to the conference for the afternoon sessions.
The takeaway was not all negative. A few buyers felt pretty good about recent trades buying AAA European CMBS for 60 cents on the dollar, driving yields up to 12% or so. But there have been only a few forced sales to date, and volume is very low.
That led to an interesting panel among special / master servicers, senior bond investors, junior bond investors and lawyers about the timing of enforcing non monetary loan defaults, the fiduciary responsibilities of the servicers to maintain a “servicing standard” and the potential liability created when folks in different parts of the cap stack want different strategies.
| An example:
If a borrower breached a Loan-to-Value covenant but was still paying on the debt, should the loan be called for default and the special servicer take an enforcement action and foreclose / sell the asset? Or, since the borrower is still paying, should the servicer waive the LTV default, maybe put in a cash sweep or some other modification, but hold off on foreclosure on the hope things get better in the next year or two. Well, if you are the senior note holder and you think things are going to get worse over the next few years, you would rather the servicer foreclose on the property immediately and get you paid back. Your thinking is, since you own the top of the capital stack (say 0 – 70% of the debt stack), even at today’s depressed process, you should get most of your money back, and you do not want to risk further deterioration in values. The problem is the junior bond holder (who owns say 70% – 90% of the capital stack) does not want the servicer to sell now. If the asset was foreclosed and sold today, his position would definitely be wiped out. So he would rather sit tight, keep collecting payments as long as possible, and keep his fingers crossed that values recover and things turn out OK. Who does the servicer listen to? What happens if the servicer also owns either the senior or junior piece? How is this conflict of interest addressed? They were referencing a “Servicing Standard” to dictate the decisions, but it sounds to me that the only people that win in this scenario are the lawyers. … |
While the debate among the servicers and investors was definitely interesting, other main themes included:
- The mood was mostly (but not entirely) negative.
- The primary CMBS market in Europe is shut down with virtually no new issuance.
- The secondary market was also shut down with the exceptions of a few forced sales at around 60 cents on the dollar.
- Sellers are only selling if they have to, because they believe government asset purchase programs might pay above market for assets in the not too distant future.
- Cap Rates are believed to be rising and commercial real estate values falling, with some predicting stabilization as early as 2009, while others are predicting 2011/2012 and beyond.
- Standards and Transparency will be harder to achieve in Europe because of privacy concerns.
I did have meetings with a major bank and rating agency to push the adoption of Backshop as an underwriting standard. I also spoke to the leadership of the CMSA about the importance of standardized underwriting and trying to make that part of any TARP / Bailout program for CMBS.
So, definitely worth the trip. Being oversees for the election was way cool.
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.
CMSA Promoting European IRP Version 2
What a week to be in London!
I find myself in London on this historical election night. I am attending the annual European conference of the Commercial Mortgage Securtization Association (CMSA), and the excitement around the U.S. election is intense.
NatCity was bought by PNC Today
So far during this consolidation, our enterprise software business has been coping pretty well.
Bank of America buying Countrywide and RBS buying ABN AMRO were negative events in the fact that, since all four were users, four contracts became two. But, we were still left with fair multiyear maintenance contracts. Bank of America buying Merrill Lynch and Lehman failing were, in a way, good for Backshop because a two big securitized players that were not on Backshop are now gone.
In all those deals, we survived the consolidation and ended up as the system of record. In this deal, PNC is the acquiring bank. Within the different divisions of NatCity, the use of Backshop is limited to the Structured Product Groups in Stamford and not the balance sheet commercial real estate group run out of Cleveland.
While I have been in the Board Room in the NatCity tower in downtown Cleveland presenting to the chief credit officer and various division heads, and we have good support among many groups to convert the entire NatCity portfolio onto Backshop, as of now Backshop is only used by SPG.
So, the question is, after PNC closes the deal and completes the acquisition, will the system of record be Backshop or will it be the PNC system?
I do not know much about the PNC loan origination system. I never tried hard to sell them because they own Midland Loan Services who in around 2002 bought an origination software company run by Mike Matheson. We competed against them in RFPs from 2002 to 2005, but they eventually pulled out of the origination business and focused on Enterprise, their loan servicing system. Nonetheless, PNC was on Midland’s system, and they were not going to change to Backshop so why waste time trying to sell?
But now, PNC just bought an ASP License to use Backshop (my standard ASP license is assumable in the event of acquisition). Midland is not in the third party origination software business, so, as far as I can tell, PNC is on a custom origination system. I’m sure that system works perfectly well for their internal use, but that proprietary approach does not advance the cause of standardizing commercial real estate underwriting.
I’ve read the combined bank will be the fifth largest in the country. An important player for sure and one that, I hope, will get on board with Backshop. But, I’d be going into the weekend with a little less stress if PNC, the acquiring bank, was on Backshop and NatCity, the one being acquired, was on Midland’s system.
I’ll keep the blog posted as this plays out over the next several months. …
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.
MBA — Serious about reform — Not that depressed, but certainly humble
My takeaway from this week’s conference was the Mortgage Bankers Association is absolutely serious about enacting reform at every level. The words transparency, standards and credibility were used over and over. Because of the massive losses and the government’s long-term commitment to providing financing for homes, the pressure to standardize is greater than ever.
However, the words are not new — people have been saying them for years. The question is: Can they and will they do it?
Believe it or not, the mood at the convention was not all that bad. Remember, the home loan market is still going along at about $40 billion per month. While that number is way down, it still represents a significant volume of loans. Lenders, brokers, little companies and lawyers are all still in business, just not as busy.
The $40 billion number is almost 100% government backed (Fannie, Freddie, FHA, etc). The private market has basically shut down because of a lack of trust in the loans, the rating agencies, the economy, etc. If not for the government intervention, this would have been a different conference, and the liquidity crunch would be affecting a lot more people.
The commercial MBA conference is San Diego in February, and I expect it will be much more depressing. The CMBS market is not supported by the government. So, with the exception of apartment building loans that Fannie and Freddie are doing, volume in commercial is basically $0.
I would call the mood humble but professional. The leadership knows we have issues as an industry, and that we should have done a better job over the past few years. But the attitude was, “We can — and will — do better.”
The folks who attend the industry’s annual trade show are generally professional, honest, hard-working mortgage bankers. The “slime” brokers don’t pay to attend these types of things. There was a kind of “pick yourself up and dust yourself off” attitude, but with an openness to learn some lessons.
The factors for positive change are all there:
1) A humbled market.
2) Government intervention with strings attached.
3) Honest people who want to make things better.
But change is hard, and the forces that stand to lose are powerful.
The mortgage industry need standards more than ever.
Can they do it? Will they do it?
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.
MBA Conference Draws Protesters
I headed into San Francisco this morning for the opening session of the 95th Annual Mortgage Bankers Association Conference and was subjected to a group of protesters objecting to the bailout, foreclosures and mortgage bankers in general. Read more
The Mother of All RFPs
Politics and the CMBS industry have become sudden (and strange) bedfellows, but recent developments may help bring open transparency to both parties.
The Department of the Treasury recently issued an RFP titled “Notice to Financial Institutions Interested in Providing Whole Loan Asset Management Services for a Portfolio of Troubles Mortgage-Related Assets.”
This is a huge opportunity.
From the RFP:
“In furtherance of its mission to ensure the safety and soundness of the U.S. financial system, and to implement the Emergency Economic Stabilization Act of 2008 (Act), the Treasury is establishing a program to purchase a variety of troubled assets. Accordingly, the Treasury seeks one or more Financial Institutions to provide asset management services for a portfolio of dollar-denominated mortgage whole loans that the Treasury will acquire from Financial Institutions.”
The submission deadline was 5 p.m. ET today, and we proposed that the government name Backshop as the CMBS reporting standard.
From our cover letter:
“While the CMBS market represents only 15% to 20% of the securitized “problem,” Backshop and CMBS.com are uniquely positioned to help solve this part of the problem. We provide the software and the data required to power a common underwriting platform that provides needed transparency into the value of the underlying assets. …”
After all, we believe the appointed asset managers should report to the DOT — and the taxpayers — in an open and transparent way.
Transparent CMBS Standards Today!
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.
What a Week to be in New York
I had four days at the Tribeca Grand this week, and it has felt a little bit like September 11, 2001. Except this time the crisis is in the economy.
The TV set (at least mine) has been glued to CNN and WSJ Online to see the latest on the bailout. The UN is in town, and the police presence is huge with boats, helicopters and sirens blaring. That certainly contributes to the “siege” or “crisis” atmosphere.
President Bush gave the Nation a definition of mortgaged backed securities. In primetime. Wow.
But when I ventured out to spend time with my clients, there did not seem to be a sense of panic. While all lenders are sitting on the fence right now, the core teams to run the infrastructure are generally in place, albeit “Right Sized.” Good real estate people can make money in all markets, and I see firms keeping long term commitments to the space.
But make no mistake, lenders that survive need either Asset Management/Servicing revenue or a big balance sheet. The markets are broken and need fixing. If the US finance system breaks and we have a George Bailey run on the banks, this business plan might suffer the same fate as the original September 11 LoopLender fiasco (See The history of Backshop and CMBS.com).
So, I had a “recovery” day where I spent the afternoon at the 10th Street Baths (1st Avenue and 10th Street), a functional place to cure whatever ails you. As long as you are OK with 120 degree saunas, 50 degree cold plunges, and getting beaten with oak branches. Try it next time you’re in New York. www.russianturkishbaths.com
Speaking of George Bailey, here’s a timely scene from “It’s a Wonderful Life”
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.
What’s in a name?
In May at the MBA tech conference in Chicago, I laid out the CMBS.com master plan to Mike Lipson of Capmark, a major master servicer and traditional mortgage broker. I have known Mike since GMAC bought Hanford/Healy in 1996 (where I worked before founding GateCapital) but he had not heard of the CMBS.com name (we have been known simply as Backshop).
Lipson said I should change the name of the company because CMBS has such a bad connotation.
He went on to predict that CMBS would never return as a dominant financing source, and the old days of private transactions and non-public data was the way of the future.
I countered that the borrowers already made the reporting trade when they took out the CMBS loan and signed their conduit loan documents which required reporting on rent rolls and operating statements to a master servicer for dissemination to investors. Plus, Google and CoStar already make that information public anyway. He was not convinced, and we agreed to disagree.
He makes a good point, though, as real estate has traditionally been very private. If we “fix” the CMBS industry by providing transparency but, in doing that, we kill the industry because borrowers do not like the product anymore, we did not accomplish the goal.
While we can address some of these concerns through technology (aggregating rent roll data, dropping tenant names, password protection), the fact remains that if the whole industry is more open and transparent, it is more open and transparent.
Will borrowers be willing to take CMBS loans in the new world of CMBS 2.0? Stay tuned. …
Black Monday and champagne?
Two major events today: Lehman Brothers filed for bankruptcy, and Bank of America went live on Backshop.
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September 15, 2008 – Lehman Brothers filed for bankruptcy today.
In 2000, I sold my first company (GateCapital) to Lehman Brothers. My partner, Jim Kehoe, ran a $5 billion primary servicing portfolio for them consisting of the assets that brought the company down — land development loans, condo construction loans, commercial developments, and even some traditional first mortgages. My experience with the firm was always positive and we were always treated fairly. A good firm with good people and, at least a few years ago, good real estate positions. They will be missed, and I am sorry to see them go.
Oh, and the Dow dropped 500 points, Merrill Lynch conducted a fire sale to Bank of America, AIG is going down the tubes because they insured all these bonds, and who knows what else is coming. So why did the entire company (at least those of us in Sausalito) hop on our boat, pop some champagne, and drink the afternoon away at Sam’s Anchor Café in Tiburon?
Because Bank of America went live on Backshop today!
Enterprise software roll outs are never easy. However, when you roll out a brand new risk management system for mortgaged backed securities in a money center bank during the worst credit crisis in a long time, the project gains a lot more focus and attention. The Backshop team within Bank of America managed all the internal approvals, and we made sure all the functionality was there for the users. As of today, Backshop is the system of record for the capital markets group at the Bank.
This represents a key date for CMBS.com because having one of the major survivors and primary issuers using the standard makes wide spread adoption a little more possible. …
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