Emerging Deal Structures Add CMBS Complexity

The evolution of commercial mortgage securitization now enables lenders to split up loans into many parts while pricing them to reflect the risk involved.

This is likely to cause some complexity down the road, according to some participants at a panel session on "tailored structures" at the Mortgage Bankers Association's Commercial Real Estate Finance/Multi-Family Conference here.

Although it is a borrower's market today, markets tend to ebb and flow and what we're experiencing today isn't forever, according to Charles Spetka, vice president, CW Capital.

In this environment of a lot of money chasing less product, credit standards erode and cap rates come down, he added. Noting that there is no free lunch, Mr. Spetka said that he expects all the pari passu and A/B/C structures that have been set up to create complexity in future.

Daniel Rubock, senior credit officer, Moody's Investors Service, also commented on the "frothiness" of the current market, which is eroding standards.

For borrowers, this is a good time to borrow since reserves are declining and leverage levels have been higher on the loans that Moody's has rated, he noted.

If this state of affairs continues, he expects that Moody's will have to start increasing subordination levels to reflect the new situation.

Moody's has seen a return to "very large pools" which provide an increasing opportunity to diversify and mitigate the underwriting issues to some extent.

But eventually, cap rates will be going back up and putting stress on value, with cash flows being "eaten up." This will increase refinancing risk, as Mr. Rubock sees it.

"Be careful what you wish for," he said, noting that 10 years ago everyone wanted a liquid market for bonds which has now happened, along with increased competition and "somewhat deteriorating underwriting standards."

For Daniel Smith, senior vice president, North American debt, GE Commercial Finance Real Estate, the question is whether the deal itself makes sense on some level.

Responding to Martin Lanigan, president and CEO, Mezz Cap, and moderator of the session, who wondered if there was going to be a soft landing, Mr. Smith said that he sees more of a "moderate bump," not a situation similar to the early 1990s.

For somebody who has put on a floating rate loan, there could be some pain as liquidity dries up and it could affect the ability to do transactions, he noted, but he doesn't see the disaster scenario of 20 years ago.

Michael Schwartz, a broker with George Smith Partners, advises "all things being equal, go to a portfolio lender." Borrowers do pay attention and will pay a premium to deal with a lender who also services, he said. He expects that pari passu note structures will cause "significant problems down the road."

Mr. Rubock expects that it would be a "real boon" to real estate if a real estate mortgage investment conduit-related legislation is passed considering that real estate is a "living, breathing, asset that sees change."

Servicers are constrained now and REMIC legislation would allow them to be more responsive to borrowers, he said.

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