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.

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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 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 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 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.

Download our entire proposal.

Transparent CMBS Standards Today!

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Jim Flaherty is CEO of 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

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.

Speaking of George Bailey, here’s a timely scene from “It’s a Wonderful Life”

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Jim Flaherty is CEO of 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 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 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 because having one of the major survivors and primary issuers using the standard makes wide spread adoption a little more possible. …

CMBS 2.0 – What went wrong and how we fix it

To have the need for 2.0 of anything, by definition, 1.0 could have been better.

Certainly that was the case with many of the internet’s first sites, and it is the case with Commercial Mortgage Backed Securities.

CMBS 1.0 had all sorts of problems, including:

  1. Too many lenders chasing too few deals resulting in high-leverage and low-cost debt financing that inflated the equity markets. Classic “Bubble” behavior that tolerated incomplete or inaccurate broker/borrower disclosure.
  2. The diminishment of the “B Piece Buyers” credit check as a result of the CDO arbitrage opportunity that existed from 2004–2007.
  3. Conflict of Interest between the issuers and the rating agencies.
  4. Inadequate reporting requirements and tools to effectively share true credit risk with all interested parties.
  5. And a whole lot of other things. …

Some of these items have a way of fixing themselves. There are no more CDOs, so B Piece buyers care about credit again, and no one would say we have too many lenders right now. The rating agency issue is a bit tricky given the historical roles of these companies; regulators will likely help decide their future role/revenue model. That leaves us with reporting requirements and standards as the only things we can truly affect as we wait for the market to return.

So what would be different about CMBS 2.0?

Lots of things but, primarily, a standardized real estate underwriting and data platform.

The “math” associated with real estate loan underwriting is basically broken up into two items: Notes and Properties. After modeling the Note to include the debt repayment terms (the liability) and the Property to model the net cash flow available after collecting the rent on the leases and paying expenses (the asset), the user can determine the Debt Service Coverage Ratio (or DSCR = Cash Flow From Property / Cash Requirement of Notes). The higher the DSCR, the safer the loan. The lower the DSCR, the riskier the loan.

On a typical CMBS loan, the debt side stays constant as most loans are fixed rate. On floating rate loans, interest rates and, therefore debt service requirements, change. As an industry (CMBS 1.0), we do a good job on the debt side of the equation, so that is not the problem.

Strengthening the property side

Since rental rates change and tenants come and go, the property side of the equation changes all the time.

As an industry (CMBS 1.0), we did not do an adequate job on reporting on the property side. The problem can be pinpointed to a lack of reporting on rent rolls and the inability for investors to run models on existing CMBS pools based on current rent rolls.

The good news is borrowers need to submit updated rent rolls as often as once a quarter, so the info is contractually available. The bad news is the Investor Reporting Package (IRP) does not require disclosure of the rent roll. So, the master servicers do not provide them electronically and the existing investor / CMBS bond modeling systems do not handle rent rolls adequately for underwriting because, historically, an underwriting was nothing more than last year’s income and expense number (as adjusted, or not, by the servicer).

There are many paths to fix the property reporting deficiencies, and the issue raised above is not a new problem for the industry. To date, standardization efforts have been waged by the CMSA and the MBA. Being actively involved in these industry efforts, I can say the timeline to reach standards is still measured in years, not months. In good times, that may have been acceptable. Not today.

The power of a common underwriting platform

When we all share a common underwriting platform and have open access to required data, we will have much-needed transparency, and every member of the CMBS market will enjoy improved processes:

  • Borrowers and brokers who are either looking for a new CMBS loan or reporting on an existing CMBS loan could enter the required data and report it to the lender or servicer in a standardized format.
  • Existing borrowers would send their rent rolls and operating statements to the master servicer in an XML format that seamlessly updates the terms of the new rent roll in the investor system.
  • Mortgage brokers could put together packages that feed directly into the lender’s system.
  • Lenders would be able to analyze credit risks of new loans for internal approval and share that data efficiently with the rating agencies and investors.
  • Investors would have access to updated surveillance reports conducted by the rating agencies, and they would be able to create their own versions of the cash flows for their bond books.
  • Appraisers could create their valuation models using the same objective data as the lenders.
  • These all seem like good enough ideas. …

We are building CMBS 2.o now

We are working to make the common CMBS platform. We are promoting acceptance by offering free accounts for all existing CMBS borrowers and individual user accounts for as little as $49/month.

Will it work? Will the borrowers come and register their loans? Will investors gain unique insight into the bonds? Will brokers prepare debt and equity marketing packages on the standard? Will the old-line banks get off their proprietary systems?

Who knows? Stay tuned.

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Jim Flaherty is CEO of 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.

Transparency vs skin

There is no question that the way in which we have conducted securitizations in the past is broken.

I agree with Ethan Penner (in his July 10, 2008 Opinion Article in the WSJ, The Future of Securitization) when he says “Yesterday’s business model has been invalidated.” However, I do not agree with his conclusion that securitization can survive “with a simple tweak.”

Mr. Penner makes the case that, in addition to transferring credit risk, the two primary benefits of securitization are

  1. a vehicle that allows a lender to match the terms of its assets and liabilities and
  2. the “transparency that it brings to bear on the system.”

Penner’s article concludes that for securitization to return the lender must originate loans and have enough equity/balance sheet to keep the first loss piece, while securitizing the senior pieces with CMBS bonds to get the benefit of risk transfer and to match fund the loans.

In other words, by the lender keeping skin in the game, the interests of the lender and the investor stay aligned and, therefore, everything will work again. The article makes no mention of the role of transparency and standards (other than them being one of the key benefits of securitization).

While aligning economic interest is absolutely a good idea, I would suggest that point is so fundamental that it should be assumed as mandatory. If the equity and the investor do not have aligned economic interests, we should not even consider bringing back securitization.

But how much equity is needed to keep all players’ interests aligned? 10%, 20%, 50%? The amount of required equity will no doubt vary depending on the market, the assets and the relationship between the equity (lender) and the investor.

History has shown that in good times the lenders will be required to keep very little (if any) skin in the game. In bad time, lenders will be required to put up more equity.

While coming up with equity is a fairly simple “tweak,” it does not represent the permanent reforms that are required.

Standards and transparency

For me, Skin in the Game is not the long-term answer (although it will probably be required for lenders to re-enter the securitization market as it crawls back to life).

The keys are standards and transparency with all parties using common underwriting models. Having spent the last eight years creating the most widely used common underwriting tool in the CMBS market, I can say that all lenders do the math the same way. Bank of America, Royal Bank of Scotland, Hypo International, CWCapital, AIG and Genworth all underwrite using the same software. Rating Agencies including Standard and Poor’s and DBRS underwrite using the same tool. The reason the market has not historically shared underwriting has to do with the fact the no common underwriting platform existed, not because the math is different from shop to shop.

The systems used by the big players were developed (at great cost) internally and typically have an Excel-based calculator. Since the models are fairly complicated (although the math itself is fairly simple), each party sets up its systems a bit differently. They do not share identical structures, and they do not communicate. And, since these systems were expensive and painful to develop, many people have vested interests in keeping the systems in place — so they don’t look like wasted technology dollars.

Underwriting is NOT an “art form”

Of course, some lenders have not been interested in sharing the math because, when times were good, they simply did not need to. I remember one prospectus where the issuer actually called underwriting an “art form” and, therefore, could not explain the math behind the numbers.

If underwriting is defined as an Art Form, then making up numbers because of aggressive assumptions becomes OK and very hard to detect. If they could sell the assets without the disclosure, why bother? One true benefit of the credit crash is that this position, as we have said, has been declared invalid.

A common underwriting platform

How do we, as an industry, get to a common underwriting platform?

To date, the industry effort to create standards has been led by the CMSA through its work on the IRP (Investor Reporting Package) and the MBA under the C-MISMO banner (Commercial Mortgage Industry Standards and Maintenance Organization).

The CMSA IRP is a decent standard in that people generally use it, but the data available in the file is deficient. The MBA has tried hard (and continues to try hard) to “herd the cats” and get everyone to agree on the data standards. It should be noted that CMISMO is not trying to standardize underwriting, only data terms and structures. Even with this reduced scope, the process of creating standards has been painfully slow and, after eight years of trying, only a handful of standards have been created with minimal industry adoption.

However, even if CMISMO were successful in short order, since there is nothing in the standards regarding underwriting, the ultimate value of the standard is questionable. That being said, we are members of CMISMO and have offered our tools, free of charge, to help the CMSA gain traction in rolling out IRP 6 (in XML).

On the private sector side, my product (Backshop) has been the most successful in gaining market acceptance. It is the only third party application in which 100% of the underwriting is done within the website and the database (no Excel!), so the system is 100% structured.

But Citi Bank, Goldman Sachs, JPMorgan, Morgan Stanley, Wachovia and others still use proprietary models. I can attest that selling enterprise software into these big companies is a slow and painful process with all sorts of barriers that often have nothing to do with the product. That being said, these institutions have never experienced an “Invalidated” business model, so the time may be now.

True, long-lasting change

If we, as a market, all used the same “calculator” and were willing to share our underwritings with the rating agencies and the investors in an open, transparent manor, that would bring true and long-lasting change to the securitization market.

It is more than a “tweak” — because creating standards is harder than raising capital.

However, if the legacy systems of a few major players are shelved and the remaining players have a path to join a common standard, the math would open up, and the risks of the loans and securities would be transparent.

Investors would no doubt return if they were comfortable they were getting a positive risk-adjusted return and that, in my opinion, is the way to bring back the CMBS market.

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Jim Flaherty is CEO of 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.