CMBS Is on the Slippery Slope Already

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.