More than once over the past year have I heard industry experts talk about the reemergence of commercial mortgage-backed securities as “CMBS 2.0” only to hear them quickly admit that, when it gets down to brass tacks, there's not a whole lot different from the way things were done in the past.
In other words, it makes for a catchy moniker. But in terms of how the loans are being originated and how the securitizations are being packaged and sold, the only real change is that underwriting standards have improved some from the heady days of 2006 and 2007. As a result, Hessam Nadji, managing director of research and advisory services with Marcus & Millichap Real Estate Investment Services, likes to say that what's happening is really more like CMBS 1.1.
Even the most modest tweak — the suggestion that, perhaps, originators should retain a piece of securitizations they arrange in order to ensure they have “skin in the game” — ended up not coming to fruition.
Given how frothy the market got and how quickly the loans originated in 2006 and 2007 have soured, tighter underwriting standards are certainly warranted. According to research firm Realpoint LLC, more than 80 percent of the delinquent unpaid balance in CMBS pools is from loans originated between 2005 through 2007.
But what is worrying is that when the market starts heating up again, there's nothing to prevent underwriting from slipping. Moreover, part of what drove the whole slicing-and-dicing machine over the cliff was the fact that there were unsophisticated buyers snatching up CMBS bonds thinking it was a risk-free investment and in the end they were buying some pretty sketchy stuff.
And, don't forget, the very final days of the CMBS peak were also marked by the emergence of commercial real estate collateralized debt obligations, which often repackaged the lowest-rated bits of previous CMBS offerings into new, highly-rated pools.
So if demand on the investor side begins to surge again for CMBS, what's to stop some of the same shenanigans from occurring given that there has been no structural changes to how the business is getting done?
Ethically, you can question whether securitizations should be sold to unsophisticated buyers. But we're all adults. And if someone wants to pay too much for something or take on more risk than they probably should, that's ultimately on them.
What is most comforting today is the fact that the Great Recession and credit crunch did thin the field. So only the most experienced and successful firms are operating within the CMBS sector. At the peak of the market, some of the worst deals were the result of firms not knowing what they were doing.
But we all know how business works. If the early CMBS issuances being done today prove successful and do not produce delinquencies, pay off their investors and deliver returns to conduit lenders and originators, new players are going to try to get in on the business.
At the end of the day, we can only rely on the idea that the Great Recession was so damaging, that the industry as a whole has learned a lesson. But I find that less than a comforting thought.