CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Notwithstanding, the overall tenor of the conference seemed to be a determined optimism projected against the overarching blanket of volatility.  European instability, a jobless recovery, a newly normalized, lumbering pace of economic growth and a constantly evolving regulatory framework continue to make uncertainty the only sure bet.  As one might expect, a number of clients we spoke with last week are adopting a cautiously optimistic demeanor for 2012 and plan to tread the market’s murky waters slowly.

Will CMBS rebound (or continue to rebound)?  Will the life co's and other non CMBS lenders be able to fill the void?  How will regulatory reform be implemented?  These questions are so 2010, and yet they stay with us.  Depending on who you believe, CMBS output in 2012 is estimated to be anywhere from $25 billion to $45 billion (compared to approximately $28 billion in 2011).  And even if the portfolio lenders have a gangbuster 2012 (which is, in fact, likely), they won't be able to bridge the void left by $360 billion of maturing debt this year.  As for Washington, we can’t even determine a cogent agenda for regulatory reform at this point, much less predict what the rules of the game will look like.

Perhaps we’ll have answers (or at least a lessened degree of uncertainty) by the mid-year in June.  

By:  Matthew Clark and Stewart McQueen

In the meantime, back in Alternate Universe A, getting a loan approved and closed still seems to be just plain tough. Spreads are volatile, hedging simply isn’t doable, and for the human beings involved in the trade, risk and reward is highly asymmetrical: an attaboy on the upside and a pink slip on the down.

Alternate universes make terrific grist for sci-fi potboilers, but are somewhat more disturbing in real life. And since it is, in fact, our real life, this bears musing about some.

A couple of things flow from this phenomenon. First, and this may fall into the no-duh category, the sale by sovereign or near sovereign banks of U.S. commercial loan portfolios is not going to be a one-month wonder. It is dead nuts certain that more portfolios of commercial mortgage loans will come to market here in the United States. The success of the Irish banks in August is certainly going to encourage the weak and the lame, particularly throughout Europe, to monetize their U.S. commercial mortgage loan portfolios to re-patriot funds and burnish liquidity. Just yesterday, one of the major French banks announced a $45 billion de-risking initiative. Wanna bet that some of that risk will be US CRE? Will there be auction fatigue on the institutional buy side? I sort of think not. For every institution that spends a zillion dollars and comes up empty, another will still see opportunity. In light of the realities of the Ordinary Course Loan Origination Universe, the siren song of get long fast by being able to put a billion dollars of seasoned loans on the books in one fell swoop will be compelling. Hey, and since the team is not building the book by onesies and twosies, we’ve got the resources to swing for the fence.

The other trend that I think we can tease out of the recent portfolio auction frenzy is that it will continue to support the rapid growth of the shadow banking market. With all the uncertainties in the formal banking market place brought to us by Dodd-Frank, Basel III, the braying of the attorneys-general community, an increasing taste for private litigation in the financial markets and the general populist anti-Wall Street narratives coming out of the Administration (egged on by a swath of the chattering class), the appetite of the major money center banks for these auctions may have a natural limit. These transactions are public circuses and highly visible. They will attract a high level of attention from the regulatory communities. How long until the regulators and the political class begin to test out the populist screed (loudly) that buying other people’s loans does not contribute to jobs?

So as deal fatigue wearies first movers (the major banks), and political exposure and regulatory attention begins to increase around bank to bank portfolio sales, the door will open for more of the fund-based shadow banking community to play a significant role in dis-intermediating the sovereign and near sovereign banks from their U.S. real estate portfolios. We’ve already seen many of the major players take a run at these portfolios this August and it’s likely to continue as competition from the banking sector lags. Moreover, where a bank might buy and hold and reap the benefits of banking economics from adding to its loan count, the non-bank market buys these assets with dynamic plans in hand. Plans to do something with these assets to earn an outsize return on its investment. Seasoned loans will be restructured, re-bundled and re-securitized. Seasoned loans will be aggressively reduced to REO for re-positioning, re-development, re-sale and re-finance. The process, net net, will transform sedate pools of portfolio assets into highly dynamic portfolios of financial assets subjected to the tender mercies of the non-bank community. It should be fun.

We’ll have to learn to live with this cognitive dissonance for a while. Eventually, though, that dissonance will become unsustainable and the two worlds will re-integrate. Will it be where institutional lenders, both banks and shadow banks, are risk-on and are aggressively growing portfolios, or a world in which risk-off is the watchword and the flow of capital will be reduced to a trickle?

I’m betting on the former because the latter is simply too depressing to contemplate. One requires growth, the other retrenchment. I’ve done retrenchment and it’s just not fun. Sometime in the next few months we’ll see whether the risk is on or the risk is off. Stay tuned.

By Rick Jones.
 

Congressman Garrett noted in his remarks that the portfolios of the GSEs are a combined $1.5 trillion-- a book with a lot of interest rate risk and a lot of unrealized gain. He said this portfolio needs to be unwound sooner rather than later. He wants to see the GSEs on the federal budget-- on the books of the U.S. government-- and he noted that in private industry, there has been a movement toward on-balance sheet and questioned why this wasn't so in Washington.

Knowing his audience, he stressed that securitization has to play a huge, vital, integral part in the resurrection of the mortgage market, and he said that securitization is vital to the movement of capital around the country. He noted the unsustainability of FHA insuring 50% of new originations and the government underwriting 95% of the mortgage market. The Congressman stated he is firmly committed to a purely private U.S. mortgage market over time, free of government subsidies or guarantees. He acknowledged concerns associated with a purely private market but also said there are competing concerns with models that include government support.

Addressing assertions from critics, the Congressman asked whether home price increases and higher down payments would be so bad (possible results of the 30-yr fixed rate mortgage not surviving without a government guarantee). He questioned whether the government is able to price catastrophic credit risk and pointed to a shoddy track record. He posited that there are other ways to keep a TBA market viable aside from a government guarantee and noted that the government steps in at the end of the day perhaps because it is allowed to, and that allowing it to increases the chances the government will do so. He noted that a discussion of servicing standards in connection with QRM never came up in crafting Dodd-Frank and suggests regulators not take the servicing issue into account. In the Risk Retention breakout session later in the morning, Tom Boemio (Sr. Project Manager, Policy, Board of Governors of the Federal Reserve System) concurred and asked: Why have servicing standards in connection with the highest quality loans only-- and not the rest?

The Congressman said there is no role for government assistance except in connection with first-time home buyers, and such assistance should be on-budget and transparent. Finally, he said that the government has to play a big role because the private sector isn't-- the old chicken-egg thing. [His prepared remarks can be found here].

At the February 7 General Session that followed, Martin Hughes of Redwood Trust further addressed the chicken and the egg issue noting that "uber government support is stifling the return of private securitization." He acknowledged that government bids are attractive and there's been no incentive for banks to sell to non-agency, and that reducing the government's role would be a game changer. Addressing the circular problem, he did note that if the government backs out before the private sector is up and running, there are sure to be problems but he suggested the status quo needs to be tested. Stating that "issuance velocity leads to issuance velocity," he also noted there are too few prime loans to get real issuance velocity. Hughes agreed that, yes, investors are mad, and investors have demands and opinions with respect to servicing practices but he believes those demands can be met and that prime jumbo can have safe attractive yields.

Hughes summarized the general sentiment by stating we need the new rules of the road-- final rules so that market participants can adapt and move ahead-- because uncertainty has been an enormous headwind. And we have uncertainty as to what the rules are and, in addition, how those rules are to be interpreted. Stay tuned for more from ASF.

By Laurie Nelson.

The main event - former Secretary of HUD Henry Cisneros' comments on the state of the CRE market. Whatever your politics, Cisneros is a vastly powerful intellect and commanding speaker. In 35 minutes (speaking without notes that I could see) he forecast the next 30 years of commercial real estate. To survey my scribbles - he is bullish on multifamily, contrasting the plight of countries suffering population decline (Japan, Spain) with the explosive growth expected Stateside (376mm by 2030; 400mm by 2050). The first Baby Boomers will turn 65 this January, with many down sizing to rentals (apparently the new trend in getting gray is "Aging in Place" - bad news for Arizona). If Generation Y will just (at some point) move themselves (and their Xboxes) out of their parents' basements at rates that even approach historical norms another 1.4mm people could be looking for a place to rent. Combining these factors with increased immigration (something like 82% of new U.S. immigrants rents for their first 5 years in this country) and lower home ownership rates (Barney Frank's victory notwithstanding), Cisneros' math leads him to a need for the construction of over 2 billion square feet of new multifamily by 2030.

However, the former mayor of San Antonio (as an aside - see this story on that city's growth during these past few years) is significantly more bearish when it comes to other asset classes - specifically office and retail. As far as retail goes, he's had overseas investors tell him they think we're 30% overbuilt (I say we are not a foot more than 25% overbuilt, but that might be the Patriot in me). The flat, jobless recovery; sector consolidation; internet shopping - the cards are stacked against retail as we near Christmas.

 Some parting highlights - Cisneros doesn't see the home mortgage interest deduction going away (you could tell this just killed him to admit). He points to strength in specialty sectors like medical and assisted living. (Did I mention the first Baby Boomers turn 65 this January?) Infrastructure of all kinds is booming - Cisneros relayed an interesting trend - internet purveyors (think Zappos building distribution sites in (or adjacent to) airports (that's how you get your wingtips the next morning). Alternate energy was another sector where technology will drive the need for growth - Green building and retrofits are now the norm.

I have more notes, and will recap the balance of the conversation in a forthcoming post - including a great panel that included the Davis Companies' Jon Davis. Again, congrats to TREC BC for a great event.
 

By Matt Clark.

All that sets the table for a sustained recovery, albeit a slow one. Yes, there are real risks to this modest good news scenario including, notably, the levels of governmental debt, the exhaustion of the strategy of pushing growth with cheap money, the likelihood of higher taxes and ham-handed regulatory action and continued governmental-bred uncertainly. So prospects for low sustained growth could yet be transmogrified into stagflation.

So, what can be done to support the growth scenario? In large measure, we need to continue to engage in the political and regulatory process to try to mitigate any further potential damage from regulatory misfires or overreach. We cannot make up aggregate demand, rehire away all the unemployment (please hire where possible) or reverse the psychology of the bad news cycle, but we can still play an important role as FinReg and its philosophic regulatory and legislative siblings get implemented.

Beyond that, I plan to fully embrace a strategy of hope. As Labor Day looms and the can kicking of summer comes to an end, we see some data from our admittedly somewhat myopic perch as a capital markets law firm sustained by transactional activity that is consistent with the upbeat scenario. That’s enough to make me mildly optimistic. Could this be vacation induced bonhomie? Maybe. But for the moment, I’m sticking with it. There’s always time to embrace despair later.

By Rick Jones.