CMBS is trying to make a comeback and reestablish a leading role in the capital markets. Several new teams have been hired and more are coming, with the new team now coming into place at Credit Suisse as one example. It is certainly not that the new teams are not well qualified or anything like that. The problem is there is already too much capacity for the number of deals which can properly qualify for the new reset underwriting that CMBS once again requires. Back in 1993, when we created the first hotel CMBS programs, we wrote a very comprehensive underwriting manual for hotel CMBS. It appears that the reset is close to what we established 17 years ago, and while that is as it should be, it means that few deals have the NOI for any product type to properly qualify for a CMBS loan. We focused then on actual underwritable cash flow, and not projections. That is what is once again required. There is also a much more limited appetite today for CMBS bonds than was the case in 2006-7, so pool sizes are much more limited

The point of all of this following on to my last blog, is that there is currently excess capacity for what is in fact just a commodity product which is basic underwriting and basic simple lending. Until the economy returns to more robust growth which translates into materially higher rents and much better cash flows, the number of deals which do qualify for CMBS will remain limited. Unfortunately, the excess capacity will lead to the inevitable relaxing of standards and lower quality loans. Then we will begin the historic slide down the quality curve as has always happened throughout financial market history. I have been through at least four such cycles, and I can see where we are headed already. The human capacity is in place, the balance sheet capacity is in place and the product quantity is not sufficient, so pressure mounts to build the business and the only way to do that is to relax standards. The recovery will simply not be fast enough to get there and maintain proper underwriting. I have even heard of relaxing of covenants already, and the CMBS market is barely back alive. Last time it took until 2005 for that to happen.

Last week I was told that the commodity nature of the CMBS business, and the capacity excess, is already back to the point that lenders are back to marketing by thinking dinner, golf or an evening at a strip club is the way to get more business. While I do not object to any of this, it is a clear sign that we already have too much money chasing too few deals, and the commodity aspects of CMBS are back much faster than I would have hoped. It invariably means standards then get pushed down and we will be headed down the slide to where we all hoped we would never go again. It may take several years, but the speed at which this is happening is far faster than many of us would have imagined even 6 months ago, and that is what worries me. The good news is by the time it gets really bad this time around I will have already retired and it will not be my problem. Congress did not fix it with Dodd Frank. The compensation system was not really fixed to eliminate risk and sloppy underwriting, and the rating agencies did not have the remake that many of us thought was really required. In many ways it is as the saying goes, the more things change the more they stay the same. As someone who has lived through it for far too many years, I can already see it coming even if it is far down the road. The young guys will soon come into the business and say they know how to do it better, they have a better model or algorithm, and we once again will be headed into the same abyss of intellectual arrogance.

Take this as a plea from a guy who has seen it all several times before and been very directly a part of it from the birth of CMBS: please keep in mind it is not the bonus this year that is all that matters. It is the long term health of the industry and the economy, and your own ability to stay earning a high income, which is what counts. A lot of people lost their hard earned wealth at Bear and Lehman, Merrill and other once great firms, because they got way out over their skis and took risks that came back to bite them severely. In November 1993, I had a conversation on the CMBS loan origination floor at Nomura with one of the bankers I was setting up the hotel CMBS lending program with. We actually said to each other –this is going to end in disaster and all these nice young MBA’s are going to end up unemployed someday. At that time we even said it would make the savings and loan crisis which had recently happened look like child’s play. It was obvious to us then that Wall St would over play the good idea we had created and would destroy itself. That will happen again unless everyone clearly understands that is where this will all end again unless real restraints stay in place for a very long time. In short, unless human greed and behavior changes.

CMBS is trying to make a comeback and reestablish a leading role in the capital markets. Several new teams have been hired and more are coming, with the new team now coming into place at Credit Suisse as one example. It is certainly not that the new teams are not well qualified or anything like that. The problem is there is already too much capacity for the number of deals which can properly qualify for the new reset underwriting that CMBS once again requires. Back in 1993, when we created the first hotel CMBS programs, we wrote a very comprehensive underwriting manual for hotel CMBS. It appears that the reset is close to what we established 17 years ago, and while that is as it should be, it means that few deals have the NOI for any product type to properly qualify for a CMBS loan. We focused then on actual underwritable cash flow, and not projections. That is what is once again required. There is also a much more limited appetite today for CMBS bonds than was the case in 2006-7, so pool sizes are much more limited

The point of all of this following on to my last blog, is that there is currently excess capacity for what is in fact just a commodity product which is basic underwriting and basic simple lending. Until the economy returns to more robust growth which translates into materially higher rents and much better cash flows, the number of deals which do qualify for CMBS will remain limited. Unfortunately, the excess capacity will lead to the inevitable relaxing of standards and lower quality loans. Then we will begin the historic slide down the quality curve as has always happened throughout financial market history. I have been through at least four such cycles, and I can see where we are headed already. The human capacity is in place, the balance sheet capacity is in place and the product quantity is not sufficient, so pressure mounts to build the business and the only way to do that is to relax standards. The recovery will simply not be fast enough to get there and maintain proper underwriting. I have even heard of relaxing of covenants already, and the CMBS market is barely back alive. Last time it took until 2005 for that to happen.

Last week I was told that the commodity nature of the CMBS business, and the capacity excess, is already back to the point that lenders are back to marketing by thinking dinner, golf or an evening at a strip club is the way to get more business. While I do not object to any of this, it is a clear sign that we already have too much money chasing too few deals, and the commodity aspects of CMBS are back much faster than I would have hoped. It invariably means standards then get pushed down and we will be headed down the slide to where we all hoped we would never go again. It may take several years, but the speed at which this is happening is far faster than many of us would have imagined even 6 months ago, and that is what worries me. The good news is by the time it gets really bad this time around I will have already retired and it will not be my problem. Congress did not fix it with Dodd Frank. The compensation system was not really fixed to eliminate risk and sloppy underwriting, and the rating agencies did not have the remake that many of us thought was really required. In many ways it is as the saying goes, the more things change the more they stay the same. As someone who has lived through it for far too many years, I can already see it coming even if it is far down the road. The young guys will soon come into the business and say they know how to do it better, they have a better model or algorithm, and we once again will be headed into the same abyss of intellectual arrogance.

Take this as a plea from a guy who has seen it all several times before and been very directly a part of it from the birth of CMBS: please keep in mind it is not the bonus this year that is all that matters. It is the long term health of the industry and the economy, and your own ability to stay earning a high income, which is what counts. A lot of people lost their hard earned wealth at Bear and Lehman, Merrill and other once great firms, because they got way out over their skis and took risks that came back to bite them severely. In November 1993, I had a conversation on the CMBS loan origination floor at Nomura with one of the bankers I was setting up the hotel CMBS lending program with. We actually said to each other –this is going to end in disaster and all these nice young MBA’s are going to end up unemployed someday. At that time we even said it would make the savings and loan crisis which had recently happened look like child’s play. It was obvious to us then that Wall St would over play the good idea we had created and would destroy itself. That will happen again unless everyone clearly understands that is where this will all end again unless real restraints stay in place for a very long time. In short, unless human greed and behavior changes.