The commercial real estate mortgage market is coming back to life and resurrecting with it the risky lending practices that killed it in the first place. Bank of America (BofA), Citigroup and Goldman Sachs have brought back their commercial mortgage-backed bonds (MBBs) and new players like Cantor Fitzgerald and Citadel have climbed aboard as well.
Since lenders are not underwriting very many new mortgages, securitization has become an attractive alternative. However, most commercial buildings are struggling to manage the mortgages they already have and cannot afford additional financing. As a result, fierce competition between lenders fighting to underwrite the modicum of available loans has compromised their underwriting standards.
Commercial MBBs were a $243 billion market in 2007, but plummeted to only $2.4 billion issued in 2009. So far in 2011 there have been 16 commercial MBB deals totaling $16.8 billion, up from 12 deals totaling $12.6 billion in 2010.
Metrics used by lenders to determine risk of default are indicating increased risk in commercial MBB deals. Appraisers are considering future rents and occupancy rates along with current market conditions. The result is a return of inflated appraisals and interest-only loans that were common during the housing market peak.
Currently, over $1 trillion worth of commercial real estate loans due in the next five years are underwater. The pressure on lenders is mounting, and with so few willing and strong borrowers they have very few loans to pool together outside of the secondary and tertiary mortgage markets.
Several commercial MBB deals underwritten in the past year include buildings with leases that expire before the loans come due, leaving them vulnerable to a loss of rental income.
first tuesday take: Lenders have very little hindsight or memory. They think with their pocketbooks and not their minds, paying attention only to the profit-making potential of the immediate future and not the long-term (and historically inevitable) results of underwriting risky mortgages.
Stricter lending for residential mortgages in light of the Great Recession should clue them in that commercial mortgages are just as vulnerable to default, but the allure of profit is just too strong to resist. [For more information regarding high-risk MBBs, see the June 2011 first tuesday article, What the rentiers got from working stiffs and the October 2010 first tuesday article, The Fed wants BofA to continue buy-backs of misrepresented mortgage-backed bonds.]
Agents and brokers must consider seeking legislation requiring commercial lenders to keep some skin in the game if we are ever to return to a stable long-term investment property outlook for buyers. When lenders retain even a small portion of risk for every commercial MBB they sell, the likelihood of a default is significantly reduced. [For more information regarding skin in the game, see the March 2011 first tuesday article, Whose skin is in the game? and the May 2010 first tuesday article, The era of reform: new regulations for bankers creating mortgage-backed securities.]
Re: “Commercial lenders take step into riskier deals” from the NY Times
