“The CMBS industry may need to confront bigger obstacles in order to rebound fully. Although most interviewees contend that a properly functioning mortgage securities engine is necessary for liquidity in the real estate capital markets, they also express serious concerns about the failures to address evident problems in CMBS underwriting, regulation, ratings and servicing since the market collapse.”

--Emerging Trends in Real Estate 2013

Maybe it's just a matter of perception but the industry executives who provided that feedback to the authors of Emerging Trends could take heart that Basel III and Dodd-Frank are both taking a swing at shoring up those problems. But that oversight is something those in the sector are less than happy about, firm in their stated belief that the sector is sufficiently self-policing. But is self-policing enough, as CMBS—projected to be a $60-billion market again by 2014—“sputters to life” (In the words of Emerging Trends), can we be headed for a repeat of the above?

“No and here's why,” says an adamant Annemarie DiCola. “The downturn in CMBS issuance was caused by the collapse of the US real estate bubble, and that collapse was primarily in single family. That triggered our own recession.”

But CMBS did in fact squeak by with a little help from the feds. “The risk retention requirement from Dodd-Frank has resulted in CMBS issuers using more stringent underwriting standards, including higher DSCR and LTV requirements and more scrutiny of borrower's credit,” says Vic Clark, managing director of originations at Centerline Capital Group.

“If you look at CMBS 1.0, there were concerns about conflicts of interest such as between the B-piece buyer and the investment-grade buyer,” states DiCola, who is CEO of Trepp. “The evolution to the so-called 2.0 was industry-driven, she counters, “clarifying the subordinate investors' control rights, the way the special servicer is compensated and the institution of an operating advisor. The sector was self-initiating these improvements even before Dodd-Frank and other regulations started to bubble up.”

Whatever the genealogy, it's still not enough. Much of what Dodd-Frank wants to accomplish in shoring up CMBS revolves around risk retention and, “in Congress' simplistic approach, they mandated that the issuer of the bonds should retain 5% of the loans on its own balance sheet” explains CREFC CEO Steve Renna, explaining that this would “at least in the mind of Congress, ensure that your underwriting quality is better.” (Stay tuned to Real Estate Forum's Cover Strory on CREFC)

CREFC responded that in the case of CMBS, retention can be achieved through the B-piece buyer. The bulk of issuers don't have balance sheets, they're designed to aggregate and sell the loans, with the B-piece buyer filling the risk-retention role. “They're not a bank in and of themselves.” In implementing regulations for risk retention, the regulators proposed the B piece buyer could never sell or lever its position for the life of the mortgages.

“We acknowledge that one of the biggest mistakes the CMBS industry made leading up to the downturn was that B piece buyers were essentially re-syndicating their B-piece position so they didn't really have skin in the game,” explains Renna. “No one was really holding the first-loss position. We acknowledge that this could lead to poor underwriting and it was a weakness in the industry.”

CREFC's position is that the B piece buyer should hold onto its position for a set period, one or two years, over which time any risks will come to light. But the association views a never-ending hold as nothing short of “draconian. We believe that, after that period of time, the B piece can transfer only to another B-piece buyer,” Renna says. That way, “You're getting someone with experience, someone who is capable of taking over the property if they essentially become the owner.”

Because of what came to light during the downturn, Renna, who represents an organization that is adamant about the need for self-policing, is a bit less adamant in how that shaped up prior to the downturn. “Let's look at how we conducted ourselves,” he says. “Because the B-piece buyer was not a true retainer of the risk, we didn't really have risk retention. And when we lost that we lost underwriting quality control. They had no skin in the game.”

With the proposals CREFC has put forth, “that B piece buyer is going to think differently about what its willing to accept in that loan pool. That's where you get quality control to the underwriters. In our self- regulation we're trying to state explicitly what is the right of investors in terms of information, transparency and the types of arrangements that can and can't happen by parties involved in the transaction.”

And if the Emerging Trends survey were to be taken today? “I'm confident that the response would be different,” he concludes.