Checking In on 9/11

Today marks the 12th year I’ve been writing this blog, which I started to provide an inside perspective on how financial reform would affect the CMBS finance markets and, more importantly, provide commentary on how it should. In my opinion, data transparency is the single most important factor in ensuring the markets stay fair, honest and healthy — and the most important tool to prevent a repeat of the 2008 financial crisis.

The reforms that were ultimately included in the 2014 Dodd-Frank Act did about everything but require full transparency. They put in things like risk retention, rating agency reform and better disclosures, but they came up short on requiring the single most important item: information on the lease payments (the rent roll).

The big-picture result of Dodd-Frank has been to effectively “deleverage” the CMBS structures. The percentage of the pool rated as junk bonds is now bigger, and the less risky AAA bonds form a smaller percentage, which creates bigger credit support levels. It also effectively pushed out the smaller, undercapitalized players because of the new capital and regulatory requirements. Most CMBS loans are now originated by the top 5 banks. All have seemingly gone well for the last several years with generally increasing originations, low loss levels, and the industry earning back its reputation.

Now we are being tested again because of the negative impact the pandemic is having on both CRE in general and CMBS specifically. In August an article in the Wall Street Journal called out that the lenders were inflating the revenue of properties to make the loans look less risky, according to an academic study and a whistleblower complaint to the SEC summarized as follows:

“A study of $650 billion of commercial mortgages originated from 2013 to 2019 found that even during normal economic times, the mortgaged properties’ net income often falls short of the amount underwritten by lenders. The underwritten amount should be a conservative estimate of how much a property earns. Instead, the actual net income trails underwritten net income by 5% or more in 28% of the loans, according to the study of nearly 40,000 loans by two finance academics at the University of Texas at Austin.”
– Wall Street Journal, August 11, 2020

Here is the full story.

The industry responded forcefully with a six-page defense of the current practices and basically said the study was flawed. They said current delinquencies are being caused by the pandemic, not bad underwriting. Download the industry response.

While I agree with the CREFC premise that underwritten income does not always match in-place income, CREFC fails to concede that, if there is a difference, investors and rating agencies deserve to know. Why is it different? Which loans? Then investors can make informed decisions.

Rent roll disclosure would accomplish this.

Today is also the 19th anniversary of 9/11, and as I finish up this post I am listening to Bruce Springsteen’s “The Rising,” top to bottom. The album always gets me and reminds me of how we only get one trip through, there are no guarantees, and you need to make the best of the ride by living an honorable life.

I remember post 9/11, the tragic events caused people to be more empathetic, respect our first responders, be unified, and were generally inspired to live honorably.

The financial crisis of 2008 did bring meaningful reform that successfully de-levered the system, making us better prepared for this Covid-induced down cycle. Professionally, my “honorable” cause is trying to make CRE finance markets better by enabling transparency at the system level and promoting the merits of opening the data to my industry peers. I’ll do my part to try and make one of the unexpected positives of Covid be triggering the final step in CMBS transparency.

I hope you all stay safe and healthy.

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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 and investors.

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