Restructuring Securitization – Follow Up to Capital Flows

This is a short follow-up of Wednesday's post on The Emerging Trends in Real Estate - Capital Flows. In particular it is more on the needs and concerns of restructuring the mortgage backed securities market, particularly in light of Washington's participation. It promises to be a slow go.


There was unanimous agreement amongst the almost 900 respondents to the Urban Land Institute’s Emerging Trends in Real Estate 2010 survey that the capital generated by commercial mortgage backed securities is essential for the industry’s recovery. And, before financing can regain a substantial foothold for commercial real estate, a monumental remodeling will have to effected on the CMBS market ... (it bears repeating)

The next big fix will be the commercial mortgage backed securities. Assuming a recovery of the financial sector, the real estate industry will have to figure out what to do with the collapsed CMBS market, “a classic example of a good idea gone horribly wrong.”

Unenviable Task for the American Securitization Forum

Last week the American Securitization Forum, for issuers, bankers, lawyers and investors involved in creating and buying asset-backed securities, met to tackle the unenviable task of cleaning up and reviving the market for MBS, both residential and commercial.

ASF Chairman Daloisio’s opening words, to a subdued group, were an understatement. "Never before has the future of securitization depended so greatly on the decisions which will be made this year in Washington.”

Members of the ASF fear that Congress, the FDIC and other regulators will impose such harsh restrictions on securitization that they will prevent it from regaining its role as a major provider of credit to to the U.S. real estate markets.

Michael Barr, assistant secretary of the U.S. Treasury, said that securitization is an "essential vehicle for providing credit to consumers and firms.” But he said legislative reforms, currently moving slowly through Congress, are needed before private securitization can return in a meaningful way. "We cannot rebuild the securitization markets on the old infrastructure," Mr. Barr said.

The Obama administration wants better disclosures on the assets backing the securities and provisions that require issuers to keep "skin in the game," or retention of some of the default risk.

No hope was offered for speedy action from Washington.

Before the private mortgage securities market can recover, issuers and investors need clarity about the regulations they will face. A bottom in real estate prices for both residential and commercial markets is also necessary for a resurgence.

This year's Forum convened in a Washington suburb instead of the glitzy Las Vegas location of years past. With the focus on regulation, they wanted easy access to the policy makers. Ironically, the meeting convention center choice for this year contained no casinos.

What a difference a few years make. Three years ago, the headline speaker was Jay Leno: this year Howard Dean and Newt Gingrich were introduced as “the entertainment.”

As concluded in Emerging Trends, “it will take years to unravel the current CMBS debacle and restructure a palatable new securitization model.”

About the American Securititization Forum from their website:

• The ASF advocates the securitization industry’s interests in various market practice, legal, accounting, tax, regulatory, legislative and policy issues.
• The ASF builds consensus, coordinates advocacy efforts, and informs and educates the securitization community and related constituencies on issues of broad importance to the industry.

Important issues for the ASF include bank capital adequacy regulations, accounting standards governing the recognition, derecognition and consolidation of assets conveyed to securitization vehicles, federal securities registration, disclosure and reporting rules, legal investment laws and restrictions, and a host of other topics that present challenges and opportunities to the domestic securitization market and its participants.

Emerging Trends in Real Estate: Capital Flows - Where's The Money?

Emerging Trends in Real Estate 2010 - Part III

My view of real estate is organic based on market-driven developments with profits generated from the successful execution of fundamentals. Huh? You know, finance it, build it, sell it, and go to the bank. But that was yesterday. Today developers are sidelined on the links with TaylorMade replacing shiny towers. Financing for new projects is as elusive as a hole in one.

So where flows the trickle of capital that lurks out there? The lead statement on Capital Flows from the Emerging Trends in Real Estate 2010 suggests that investors must get ahead of available capital in order to score:

“The key to success in real estate investing is to follow the capital flows, not the fundamentals. Anticipate what capital wants and be there.”

The hens are chasing the fox. The play has changed but the game changer is still leverage.

ET predicts it will be a slow comeback for lenders in 2010. Debt markets will start to resuscitate but will remain “far from normalized in the wake of unprecedented deleveraging.” The survey respondents agree that the debt markets will bottom this year and any lending will be “conservative, expensive, and extended only to most-favored relationships.”

With credit on a shoestring, commercial real estate markets in 2010 will be led by all-cash investors buying quality properties from distressed borrowers or directly from lender’s REO portfolio. Distressed sales will help the market find firm footing in a bottom and form a foundation for a recovery.

Before financing can regain a substantial foothold for commercial real estate, a monumental remodeling will have to effected on the CMBS market ...

The next big fix will be the commercial mortgage backed securities. Assuming a recovery of the financial sector, the real estate industry will have to figure out what to do with the collapsed CMBS market, “a classic example of a good idea gone horribly wrong.”

Lenders loosened underwriting standards and off-loaded risky loans into securities markets, fueling deals, ballooning prices, over-borrowing and over-building. “Ironically, CMBS was a solution for recovering from the last real estate debacle, but got us caught in a worse trap because the structures became too complex.” Now mired in litigation hell, special servicers and multitranched borrowers will fight it out for years.

With the bubble blown sky-high, hundreds of billions of dollars of CMBS loans will come due over the next five to 10 years and there is ZERO appetite by bond buyers to return to the CMBS orgy. In virtual unanimity, the Emerging Trends respondents agree that the overall real estate industry revival depends on reconstituting the CMBS markets and restoring confidence. But there is no quick fix on the horizon. “Reinventing a new detranched, ‘back-to-basics’ CMBS model could take several years at least.”

The unraveling of the CMBS market may require government intervention for survival. Most of the respondents believe that the government will come to the rescue to backstop the mass of loans coming due. After all the feds came to the aid of Fannie and Freddie. The difference being that Fannie and Freddie is the darling child of every politician in this country and the American Dream, although battered, is still alive and well.

Here are the top capital markets’ lessons learned by investors as they scramble to stay alive:

• Diversification doesn’t overcome systemic risk.
• In the global marketplace, all regions and credit markets inextricably link.
• High credit ratings don’t necessarily mean high-quality investments.
• Mathematical models cannot fully simulate or manage risk.
• Risk of borrowing short to invest in illiquid assets cannot be hedged.
• “Tails” on bell-shaped curves exist for a reason.
  

Here’s some very good advice from one respondent:

“When you justify a deal based on financial engineering, it’s the kiss of death,” says an interviewee. “The industry did leverage entirely wrong, putting increasing amounts of debt on riskier and riskier deals. For leverage to really work, you should put it on the least-risky deals in the early part of market cycles.”

For the small sliver of the debt market that is still in the lending business, the loans look like a different species from the issuances of prior years. We’re talking about 60 to 65 percent loan to value ratios, 7 to 7.25 percent interest rates and 1.4 debt-service coverage. The recent aggressive financial models for commercial real estate deals can’t be supported on the shoulders of the “New Deal.”

Currently in its 31th edition, Emerging Trends in Real Estate 2010 is collaboration between the Urban Land Institute and PricewaterhouseCoopers and is a highly anticipated annual industry review. The report was based on surveys and interviews with more than 900 top industry professionals including developers, investors, brokers, analysts, researchers, appraisers, and academics.