The 2016 CRE Finance Council Industry Leaders Conference, held this week in Miami, was dominated by two topics– risk retention and liquidity. Almost all the forums, panels and presentations at the conference were overshadowed by the specter of risk retention and more general concerns about liquidity.
While we at Crunched Credit have, during most of 2016, been deeply concerned about the likely impact of risk retention in 2017 and its knock-on effect in the run up to its effective date, we sometimes felt that we were preaching to an empty church. But boy, the pews are full now and the industry has well and surely woken up to the risks that the Risk Retention Rule poses for the business models underlying the CMBS industry.
Dechert’s Rick Jones participated on a panel with several other industry leaders to discuss risk retention in front of an overcapacity crowd. Many topics were covered in the lively and fast-paced discussion, but here is what is on the top of our minds:
- We need a solution for the risk retention conundrum and, right now, the industry doesn’t have it and is running out of time.
- If the B-Piece buyer is the General on the White Horse for this crisis, can they, or will they, step up; and is there enough capital in the B-piece world to actually keep the CMBS machine humming?
- Where in the world do we find what amounts to new ten-year money every single year?
- If new capital relies on complex equity structure and finely reasoned interpretation of the language of the Rule, will these pass muster when the regulators decide to regulate?
- How much of this is just a pricing problem? Will the underlying borrowers provide the additional coupon to salve the risk-based capital wounds created by risk retention?
- Is there any life in the vertical strip? Can any institution sort out a way to hold the strip and still earn an adequate return in this business?
- Is this all simply too much for some originators, B-piece buyers and banks? Might this drive some market participants out?
- What happens in the run up to the risk retention rules’ effective date of Christmas Eve of 2016? Does that bode well or ill for volumes in 2016? Do we run like crazy to get as much done before the risk retention rules hit? Does the market seize up in late Q3 or early Q4 if there is not a deep and obvious supply of risk retention compliance structures ready to go on January 1?
- Any chance for a Hail Mary legislative fix? Maybe for the SBSC segment?
The level of anxiety over liquidity in general was palpable. While risk retention is itself a big part of the liquidity problem, it is regrettably not the end of it. Are there enough investors to buy our bonds? Where are spreads going? Will the banks continue to make a market and what about this horrible Fundamental Review of the Trading Book Rule? Can we run the current business model with vastly diminished trading books? If risk retention requires a material price adjustment, or if some of these other liquidity problems mean pricing has to change, does that make CMBS uncompetitive? The Prudential regulators fired a shot across the bow of the broader banking market in December about excess concentrations in real estate. Is it likely to affect the willingness of banks to originate real estate credit? Lots of questions, lots of concerns, lots of bloviation. Little wisdom.
The conference demonstrated that our industry shows a truly impressive capacity to maintain two mutually exclusive and totally contradictory notions about the market in our collective brains simultaneously. While the motif of the entire meeting was risk retention, liquidity and regulatory concern, there was much industry chatter and panel conversation focused on the fact that fundamentals remain mostly sound; continued, steady performance of commercial real estate markets during 2016 could be expected. There was a certain licking of lips over the looming maturity wall and even a positive nod or two to our slowly grinding-up economy. Many panelists said that they thought there was a couple of years of more growth in this economy (okay, it’s 2006, but 2008 is not two years away…). Conventional wisdom is that we will see something in the range of $100+ billion in CMBS production this year, and pretty much everyone I talked to thought, in a Lake Wobegon-ish sort of way, that, at least in their shop, volumes would be up. Jack Cohen’s Roundtable, which as usual kicked off the festivities with a fascinating discussion of the markets, was a perfect exemplar of this, where panelist after panelist said the equivalent of “Yes, it’s absolutely terrific and absolutely frightening at the same time.” It’s comfortingly hard to be proved wrong in the prognostication business when you think that we’re both in the eighth year of a continuing expansion and doomed.
Looking at: the road right in front of us; the commercial bricks and sticks markets; a fresh year with fresh investor allocations with a need to put money to work; a consensus 2% GNP growth for 2016; and the wall of maturities mentioned above, things don’t look that bad. Look at the continued governmental assault on liquidity, the coming risk retention rule, the geopolitical risks facing the country and the slowing world economy and you can get gloomy.
Anyway, that seems to be where everyone’s head was — positive, but gloomy; worried, but ready to get back to work. A conundrum. “A Puzzlement,” said the King in The King and I. Well, no one promised this was going to be easy. It seems to us here at Crunched Credit that everyone was pretty well right. There are opportunities, there are risks, there are likely to be winners and losers. Standby, it’s going to be a wild ride.