CMBS Needs Some Skin in the Game

There has been virtually no new issuance of CMBS since the summer of last year. The result has been a reduction in the number of investment sales in New York with prices over $100 million of 85% in 2008 versus 2007. Thus far in 2009, there have been only 2 transactions which have exceeded $100 million. Securitizations are used for smaller loans as well, however, the  majority of this sector consists of larger loans.Various reports have indicated approximately $180 billion to as much as $400 billion of commercial real estate financing maturing in 2009. Most of this financing is CMBS and a significant percentage is collateralized by assets located in New York. The market does not have the ability to refinance this magnitude of capital without access to the public markets. Even performing, low LTV (even using today’s adjusted values) loans with strong sponsorship will find refinancing challenging if the aggregate amount of dollars needed is too large. It is, therefore, critical to get the CMBS market operating again, in one form or another.The government is trying to stimulate all credit markets including the CMBS market. The TARP includes TALF 1.0 which is geared towards supporting asset backed securities collateralized by credit card debt, student loans and auto loans. It also has an allocation to purchase newly originated AAA traunches of  CMBS. TALF 2.0, which was born out of the “Geithner Plan”, has an interesting component which will attempt to create a pool of buyers of legacy CMBS as well as other toxic assets. Created via the formation of public/private parnerships, this pool of buyers will consist of competitive bidders for these assets. Leverage will be available at a ratio of as much as 10 to 1. Balance sheets of financial firms could be significantly enhanced based upon the extent to which this process is successful.  How did the CMBS market deteriorate?   Similar to the mechanism which caused problems with RMBS, no one had any skin in the game……. until the end of the process. Along the way, fees were made and exposure was passed on to the next one in line. Loans were orignated and sold to the secondary market. Pools of loans were securitized and divided into traunches. Rating agencies gave their blessing and when the securities went bad, the investors who purchased them were left holding the bag.The question is, What will convince investors to purchase these securities in the future? Perhaps something like this could help:The originator of the loan should be required to keep a first loss position of let’s say 20% on their balance sheet and could then sell 80% of the loan to the secondary market. The lender would then be compelled to make prudent decisions about what loans they are making because they will have skin in the game. The secondary market securitizer should have to keep a second loss position of let’s say 10%, which would make them scrutinize the collateral, layering in another slice of due diligence. The securitizer could then sell the balance of the securities to institutional investors. With a 30% loss position in front of  the investors, a rating agency would no longer be necessary to give comfort to the investors. The percentages of loss positions could vary greatly, but the concept is to have market participants put their money where their mouth is rather than merely processing a financial instrument for a fee and then passing all of the risk on to someone else.The market desperately needs access to massive amounts of capital and a fix to the CMBS market would be a start.