Residential mortgages were a ticking time bomb of foreclosures waiting to go off in 2007. Hollywood tackled the detonation – and the lead up – in the film The Big Short. But could commercial mortgages, many of which are part of securities packages that are coming due on Dec. 24, lead to another foreclosure explosion?
This was the question put to a packed house of more than 120 guests and members at the November meeting of the Charlotte chapter of Commercial Real Estate Women at the Charlotte Country Club on Tuesday.
A panel discussion, moderated by media personality and public relations expert Will Boye, talked about Commercial Mortgage Backed Securities and their impact on the current real estate world in Charlotte and around the nation.
The panel included Stacy Ackerman of K&L Gates, Chris Van Heerden from Wells Fargo and Kelly McLaren of the Finley Group.
Boye kicked off the event with a brief discussion of what constitutes CMBS and how the market get into the current situation with a Christmas Eve deadline.
“Essentially, a bunch of commercial loans are brought together and sold off to investors as a group,” said Boye of Yellow Duck Marketing. “But because they are more complex, sometimes they’re more volatile.”
Boye went on to explain that the layering of lenders, and who is the lender occupying the first loss position, can get complicated when the real estate loan in question comes due.
“This really begins with the borrower who has a commercial real estate project they are looking to finance and then they start the loan process,” said Ackerman. “After the loan documentation is complete you’ll go into your loan closing. Sometimes it is six months before, sometimes the day before. After the closing the particular securitization is identified. Rating agencies are then going to give a grade to the loan.”
Ackerman said there is a lot of research that goes on before investors decide to purchase the CMBS.
“Then there will be a purchaser of the loan and once all of that due diligence is done the loans are sold into a real estate trust,” she explained. “You then have different players coming in to interact with your loan, and these loans and securities are held by pension funds, institutional investors and other investors.”
Looking back at the history of the CMBS market over the past decade, Boye noted that the amount of debt nationwide issued for CMBS declined precipitously between 2007 and 2008 as a result of the recession.
And the reason that December 2016 is a big date for many of the CMBS is that most such securities packages have a ten-year term.
The panel discussed an estimate of about $90 billion in CMBS on the current commercial real estate market across the country. Could that amount of debt be about to fall into foreclosure on Christmas Eve, much like the residential foreclosure bomb last decade?
For his part, Van Heerden had some reassuring words for the gathered crowd.
“CMBS is just a part of the commercial real estate market,” he said. “We are seeing about 85 percent of the CMBS loans that are maturing are refinancing, but with a bank loan. It is migrating away from CMBS to more traditional funding sources.”
Van Heerden said that investors looking to refinance don’t find CMBS as attractive as it did ten years ago.
“Many people aren’t using CMBS as much is because the market about ten years ago was distorted,” he explained. “We had regulations that encouraged banks to own AAA securities. That regulation produced demand for those securities and the market met that demand. That helped to bring about the financial crisis.”
Van Heerden said the CMBS were likely to be ranked or graded as AAA securities because the risk was spread amongst many properties. But today, investors that Van Heerden called “distressed” are more likely to look for traditional bank loans.
McLaren spoke about her work as a receiver of distressed properties.
“A receiver acts as a disinterested third party that comes in during breach of contract or foreclosure and we take possession of the property away from to the borrower,” she said. “That receivers role is to maintain the status quo but also stabilize the asset so that rent is still collected, there’s no health or safety violations and make sure the new buyer could have access to all parts of the property – like a parking lot.”
McLaren said even though the receiver technically works for the court they are still using the lenders funding.
“In the issuance of a CMBS deal you have to go through a group for approval,” she said. “Sometimes the person representing the real estate trust doesn’t understand what is going on. Sometimes they are sophisticated and sometimes not.”
CMBS are likely to be retail properties.
“Retail makes up the bulk and then some office and some multifamily properties,” Van Heerden said. “Retail seems to win out because balance sheet operators are usually less competitive with retail loans. You have all these different funding choices to consider and borrowers often choose CMBS because of the ten-year term of the loans. But the ability to offer CMBS is coming out of the market with regulations coming in next month.”
The regulation in question that is cooling the CMBS market is a new federal requirement of “risk retention” on the part of debt issuers.
“Risk retention was implemented by regulators to require sponsors of securitization to hold on to at least five percent of a deal which requires them to basically eat their own cooking and have some skin in the game,” said Ackerman. “We have a lot of Chicken Littles running around but I’m more optimistic about this. I think the general consensus in the industry is that risk retention is going to work out well.”
McLaren agreed that the sky really isn’t falling and said much of the $30 billion outstanding in CMBS could be refinanced or sold to investors at a small discount before the Dec. 24 deadline.
In closing, Van Heerden added, “CMBS is not the next Big Short.”