Tuesday, April 14, 2009

Why CRE Lending Needs its Own Center for Disease Control

Imagine there is a disease that lies dormant for between 5 and 20 years, and then, over a 3 to 5 year period, kills 5 – 10% of our population. Now, suppose the first signs of a new outbreak are occurring. Would it surprise you if there was no central data repository to monitor the spread of the disease? That no teams of scientists study who survives, and who doesn’t? That no theories are developed to avert the next outbreak?

Of course, that would never happen in the United States. Virtually every disease outbreak and death in the US is reported to the Center for Disease Control (CDC), which identifies trends and coordinates research on the causes and prevention of disease. Any serious outbreak receives almost immediate attention and study.

There is nothing like the CDC when it comes to reporting and studying underperforming CRE loans. Obviously, human lives are more important than avoiding losses on loans, but it still puzzles me that there is no systematic, comprehensive effort to track defaults, diagnose the problems, and autopsy the failures. It’s apparent we are going to see major performance issues on CRE loans (see, for example, this post from Zero Hedge). Who is going to collect data and study what happens this time so we can avoid or minimize future losses?

There are some counterarguments to making the effort. Some people believe the problems are already diagnosed – for example, underwriting standards (LTV, DSC, interest only structures, etc.) were too aggressive. Undoubtedly that’s true, but it doesn’t explain everything. For example, here’s a table from the previously mentioned Zero Hedge post showing losses some CMBS loans:


(Click on image for a larger version in a new window)

The last loan on the list is Coastal Carolina Campus Point. Costar had this to report when the loan hit the watch list:

Coastal Carolina Campus Point, Myrtle Beach, SC
The loan on this 144-unit multifamily student housing apartment complex was transferred to the special servicer in January 2005 due to monetary default and became real estate owned in November 2005. The property is 67% occupied. The total exposure on the loan was $11.6 million as of November 2006. The property is listed for sale with Marcus & Millichap with an anticipated February 2007 disposition date.

I’d like to know how it’s possible to lose almost 70% of principal on a multifamily deal that became REO in 2005. Does anyone really believe there are no lessons to be learned from deals like this?

You might say that figuring out the lessons are the responsibility of individual lenders. However, even the biggest lenders only see a small portion of the defaults. You might say that this is a function for the rating agencies, and I would agree with you, but do we really want this information to be proprietary? Also, rated deals are only a fraction of all CRE deals, and there are some sectors which are not covered by the rating agencies at all (for example, construction loans). Finally, as I’ve previously argued, most lenders and rating agencies are not focused on the right variables. 

Like the CDC, I think this is something that is best done by the government. The information should be in the public domain, and only regulatory agencies have access to all the information. As I’ve previously discussed, CRE loan underwriting never seems to improve, in part because the feedback cycle is very long. The current downturn is the first severe test of CRE loans since the early 1990’s, and is an opportunity to learn from our mistakes which probably won’t be repeated for many years. Will we take advantage of it, or just bury the bodies?