The best things about conferences are the unexpected and unplanned meetings.
Last night at the CMSA/MBA Capital Markets Conference in Washington, DC, I enjoyed an experience that restores a bit of hope: a illuminating dinner with three CMBS experts, each with his own insight into saving the market.
I had dinner with:
– Toby Cobb, head of Deutsche Bank’s real estate group, on special assignment to monitor developments in Washington, DC
– Pat Sargent, a seasoned real estate and securitization lawyer with Andrews Kurth, and the incoming president of the CMSA
– Jack Toliver, head of the CMBS ratings group at rating agency DBRS
All three share a desire and passion to get the CMBS market working again, and each brought a unique prospective. After a few rounds of cocktails and some really big steaks, each person proposed the one thing they thought was most critical to the market’s recovery:
1. No Government Bailout
Toby Cobb thinks the government is doing more harm than good when it comes to CMBS.
The change in direction on TARP from buying assets, including CMBS, to investing directly in bank stock, is an example. The announcement and switch caused disruption and uncertainty that contributed to the free fall in CMBS over the past 60 days.
He thought the government could play a leadership role in helping the private sector come up with a plan, but that the economics should be left in the private sector.
2. Rule of Law
The issue that most concerns Pat Sargent is the renegotiation of contracts.
The entire economy is based on the strength and enforceability of contracts. If these contracts are changed, especially if they are changed by servicers in a self-serving way, the entire structures lose credibility.
Without structural credibility, investors will be less likely to return to CMBS.
3. First Pay Rating
Jack Toliver, a vocal critic of the lending practices of 2006–2007, thinks the SEC can provide some help to investors in Structured Products by differentiating AAA securities that are “First Pay.”
In a standard CMBS deal, the AAA class gets 100% of the payments from 0% to say 70%. That means, even if real estate values go to 50 cents on the dollar, the AAA will get all of the cash, and, therefore, recover 50 cents and only lose the next 20 cents.
In other words, the bonds get the first money out of the assets even if they do not get paid back to par. But there are also AAA rated CDOs that were the “top” pieces of B notes, that were subject to senior A notes. They achieved AAA ratings because it was thought not all B notes would default, so at least some of them would pay off and, therefore, the first bonds to receive the payments were “safe.”
But that is not the case, and these are not “First Pay” securities. They rely on an underlying senior security to pay off before the junior security receives its first dollar. The value of that security can go to zero if all the B Notes fail, where the value of a “First Pay” CMBS bond would not go to zero. That should be differentiated.
And, of course, I was promoting transparency to the rent roll and standardized underwriting models (the common calculator).
All good ideas if you ask me …
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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.