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Secondary Market.

MBA and other leading voices in the field of mortgage finance are proud of saying that the current "credit crunch" has not had any impact on the availability of credit to finance home purchases and mortgage refinancings. This is a testament to the efficiency of the secondary market for residential mortgage loans. Standardized underwriting, documentation, mortgage terms and servicing requirements were the necessary ingredients leading to wide investor appeal for generic mortgage-related securities. Parallels to the residential secondary market are important guides for developing approaches for a secondary market for commercial mortgages.

The starting point for analysis is the question: why isn't there an efficiently operating secondary market for commercial loans today? The most obvious answers are a lack of the following: uniform underwriting standards, uniform documentation, a critical mass of mortgage product to create diversified pools and sufficient economic incentives to attract large numbers of high-quality specialized servicers and originators.

The current S&L and banking crisis may provide the commercial mortgage lending industry with a unique opportunity to rapidly develop a more efficient secondary market for commercial mortgage loans. Both the RTC and the FDIC are sitting on a high volume of these loans. By some estimates the RTC has about $50 billion of commercial loans of which $25 billion to $28 billion are classified as "subperforming or non-performing." There are estimates that when the banking crisis is finally resolved, as much as $500 billion will have passed through the FDIC's hands.

The RTC has wisely and skillfully put the "performing" portfolio to use by creating RTC securities. There have been three of these issues to date. The issues have attracted a lot of investor interest and regular issues are planned for the future.

As noted, the real potential for a secondary market for commercial mortgages is with those loans that are not performing. In this regard the RTC has been studying the option of possibly re-underwriting those loans to make a portion of the debt investment grade. The RTC has been exploring this because it believes that this may be the best sales execution compared to severe discounts to par associated with whole loan sales.

The senior-investment-grade portion of the loan is created by modifying the mortgage to an appropriate debt-service-coverage ratio based on historic collateral performance and rating agency standards. The non-investments-grade portion of the debt would be structured into subordinated mezzanine (B) and subordinated junior (C) pieces to allow the holder, presumably the RTC, to capture the upside potential of the loan if the net income characteristics of the property improve. The mezzanine piece can be sold or held for higher recovery as it becomes more seasoned. The junior piece affords the RTC the opportunity for full recovery of the principal. Some RTC staff members and independent analysts have predicted that cash recoveries from the sale of the investment-grade portion should exceed the recoveries currently obstained through whole loan dispositions.

The RTC staff cites other benefits to programmatic re-underwriting of commercial mortgages, such as: * Reduce the cost of the bailout to taxpayers. * Re-underwritten senior debt will reduce rating agency

required reserve/subordination levels significantly. * Creates an opportunity to correct deficiencies in loan

documents which currently impair marketability. * Loan maturities are extended to avoid short-term balloon

risk. Thereby allowing commercial borrowers to

participate in the program to avail themselves of the

refinancing liquidity provided. * Establishes a non-disruptive system to effectively re-size

commercial credits with no forgiveness of debt. * Standardized mortgage documents loan administration

and credit policies will be created and implemented

which will have a positive effect on the liquidity of

commercial real estate loans nationally. * Prevent a further downward spiral of commercial

property values by immediately establishing a support level

upon which the commercial real estate markets can

begin to stabilize and actually recover. * Allow mortgage companies and commercial banks that

would be chosen by the RTC to do the re-underwriting

and servicing to increase their earnings.

Since there appears to be so many good reasons to implement a re-underwriting program, why hasn't the RTC implemented such a program? The answer in part has more to do with political rationality than economic logic. There are two concerns. The first involves the potential for complaints lodged by commercial borrowers whose under-performing loans the RTC chooses not to re-underwrite. The second concern involves rewarding a "bad borrower" with new and better terms. These are legitimate concerns to address and they should not be dismissed summarily. We believe, however, that the unique opportunity to quickly expand the secondary market for commercial loans and the potential taxpayer savings of $5 billion to $7 billion is so valuable, that the RTC, with support from banking and mortgage banking industries, should be able to address those concerns and move ahead with a securitization program for under-performing commercial mortgages. MBA will continue to press this issue.
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Title Annotation:commercial mortgages
Author:Taliefero, Michael S.
Publication:Mortgage Banking
Article Type:Column
Date:May 1, 1992
Previous Article:Technology.
Next Article:Boardroom view.

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