Earlier this month CREFC held its “Commercial Real Estate Finance Summit – West” in Santa Monica, CA, which – while not nearly as large as the annual conference in New York – was still very well attended (roughly 175 attendees, an increase over last year).

Given the sentiment earlier this year in Miami, the fluctuation in spreads over the past couple quarters, and the (now undeniably) slow start to 2016 for many in the industry, the two topics du jour for the Summit should come as no surprise: risk retention and the state of the market.

No matter the stated topic, most panels (and quite a few conversations), devolved quickly into a discussion of those two subjects (albeit from a variety of different perspectives). Here are some of the major takeaways:

On the topic of real estate fundamentals and underwriting (and risk retention and the state of the market…) –

  • Everyone seems to agree that real estate fundamentals are not really the source of volatility in the market (at least not yet…).
  • This is not 2006 all over again: loan-to-value ratios are more conservative, CMBS is trying to focus more on core markets, B-piece buyers are exerting more control than ever, and amortization is a more regular feature of securitized loans.
  • Speaking of loan-to-value ratios, it is worth noting that rating agency stressed LTVs may have just peaked; while underwritten LTVs for CMBS – on the other hand – are markedly down (this is now the land of 65% LTV, or maybe 60%, or maybe even 57%…). However, everyone seemed quick to concede that no one really knows what the “V” in any particular LTV actually is.
  • But, the picture has already become a little less rosy for some. Less liquidity in the market may already be hurting some hotel refinancings; and, the consensus seems to be that now is not a good time to be in the student housing game
  • So, are people worried about the fundamentals? Well, yes and no. Even if real estate fundamentals look good now, some panelists were worried about what will happen now that unemployment levels are down and office occupancy rates will not be growing as fast as they have been?
  • And, the specter of rate normalization is still out there (although no one seems too worried about it). What would today’s floating rate loans look like if (when?) 30-day LIBOR hits 2%?

What about volatility? (and risk retention and the state of the market…):

  • The CMBS world has already experienced a lot of volatility so far this year, spreads widened a lot early on, with a little retracing recently. CMBS issuance has been slow so far, very slow.
  • Meanwhile, a lot of liquidity has dried up (or been scared off by the recent volatility), which has contributed to a thinning-the-pack among originators (I counted 5 separate time that someone pointed out there now just over 30 shops contributing loans to this year’s deals, compared to around 45 last year).
  • And, at the same time, all the regulation kicking in this year is already creating friction costs and a significant negative headwind for the industry.
  • So, when will things really ramp back up? When CMBS gets back to what it (historically) did best: competing on pricing and on certainty of execution (one panelist suggested that rates need to come down to around 4.5% before the pace will pick back up).
  • But even when things do pick back up, several speakers seemed willing to concede that CMBS will not be having any +$230 Billion years anytime soon.

The main event: Risk Retention (and the state of the market…):

  • What does everyone think the landscape is going to look like after December 24th? (Or, more accurately, after Labor Day, given all the practical realities of actually originating loans, going to market, and closing securitizations.) Well it depends on who you ask.
  • B-piece buyers seemed to think that horizontal risk retention is what the market will trend towards (in the long run), and that it will look a lot like the process that issuers and B-piece buyers go through now, it will just cost more. They are working on raising dedicated funds to buy those horizontal strips, and hold them for the full 5 years (at least; and, probably longer). But, it is hard to find capital that is willing to be locked up that long.
  • Big-bank issuers, on the other hand, seemed to think that vertical risk retention would win out, at the end of the day. Horizontal risk retention seems nice in theory, but they are worried that it is going to be too expensive. And, no one has quite gotten comfortable with the “obligation risk” associated with selling those horizontal strips (the big banks don’t want regulators knocking on their doors – 3 or 4 years after the fact – just because a buyer they never controlled does some improper hedging).
  • Then again, maybe HR 4620 will save the day. Although, if HR 4620 does not make it over the finish line, everyone also seemed to agree that the next best thing would be certainty. Certainty that the rules won’t change anymore, and certainty that they will go into effect when everyone expects. To paraphrase one panelist: “We don’t care what the rules are, just tell us what the rules are and stick with it.”
  • There were a few other things that everyone seemed to agree on, like the need for price discovery on what B-piece buyers are actually going to charge for holding the horizontal risk retention strips; and that (as a practical matter) risk retention probably would not actually make underwriting any more conservative.
  • Several panelists also observed that until the capital markets settle on what the most efficient risk retention approach really is we all may be in for even more volatility, as loan originators start trying to factor their anticipated risk retention strategies into the terms they quote to borrowers.
  • On a (somewhat) more optimistic note, there also seemed to be a fair amount of agreement that even though risk retention was going to cause everyone some short term pain, in the long run it would be good for the market. In the long run, a number panelists seemed to agree, risk retention might ultimately result in a smaller market but because it was smaller it would also be a healthier market.

But wait, aren’t there a whole bunch of other regulations that we need to talk about?

Yes, there are. But, if you were just listening to the panels, those other regulations would be easy to miss:

  • If not for the CEO certification requirement, Reg AB II might not have come up at all. What discussion there was generally revolved around whether or not most issuers would continue to be comfortable including loans they did not originate in their securitization, and what that was going to mean for everyone without a shelf of their own.
  • And, aside from one or two brief mentions in connection with regional banks, Basel III got surprisingly little attention.

That’s all for now. But, with CREFC’s annual conference in New York less than three weeks away, we are sure to be hearing plenty more on all of these topics very soon.