Brokers can help their clients find opportunity in a dry CMBS market

Jeffrey D. Black, analyst, Colliers Meredith & Grew

As published in Scotsman Guide's Commercial Edition, July 2009.

Despite the government's plans to jump-start lending by pumping billions of dollars into the financial sector, banks and portfolio lenders are still saddled with about $2 trillion in toxic assets -- the underlying credit quality of which continues to deteriorate. Until liquidity is restored to the secondary markets, downward pressure on impaired asset prices will continue to erode banks' capitalization levels, requiring them to warehouse taxpayer money and continue to curtail new lending.

As an asset class, commercial real estate has only just begun to correct. This correction is primarily related to the price and availability of credit, on which real estate values depend heavily. Nonetheless, risk premiums in the markets for commercial real estate and corporate debt have increased to historically wide levels in the past 18 months. This suggests that market participants have become intensely risk-averse after the unbridled optimism and insatiable demand for commercial mortgage-backed securities (CMBSs) seen from 2003 to 2007.

Those factors allowed conduit lenders to recycle capital, which supported new originations and increased credit availability while driving down the cost of capital. Sustainable conduit lending, however, depends on a reliable and transparent exit strategy via secondary-market securitization. Conduit lenders were not designed to be balance-sheet lenders, and the collapse of the secondary market for securitized paper forced them to hold illiquid inventories of bundled notes on their books devoid of an exit strategy.

Today, despite the government-bailout money they have received, many banks have been reluctant to liquidate many of their impaired assets. They are unwilling to realize further losses by setting heavily discounted prices for their illiquid-asset inventories, further log-jamming the industry. At its core, this crisis is one of oversupply, and a large bid-ask gap between buyers and sellers has resulted in virtually no trades and therefore no data to inform a consensus on the cost of capital.

Mortgage brokers who understand the state of the CMBS market and who know where opportunities still exist can best help their clients find capital in this weakened credit environment.

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