CMBS Hiatus Takes Long-Term Toll

MBA (5/12/2008 ) Murray, Michael
Prudential Financial Inc., Newark, N.J., turned a short-term hiatus from the commercial mortgage backed securities (CMBS) market into a long-term exit, despite potential opportunities in the future.

Prudential Mortgage Capital originated nearly $14.5 billion in 2007 in commercial mortgages with $6.86 billion originated from the general account, $3.9 billion in the capital markets, $1.77 billion from Fannie Mae and Freddie Mac and $329 million in FHA lending—$3.6 billion total in agency lending for 2007.

During the first quarter this year, Prudential said it would temporarily exit the CMBS marketplace and then return, but it stayed out of CMBS during the entire first quarter—without an application—because of market volatility. Prudential Asset Management reported this month a pre-tax loss of $107 million in its commercial mortgage securitization operations for the first quarter of the year.

“Prudential decided to exit the commercial mortgage securitization business because of the current market environment and associated volatility, and because the business case is not proving out,” said Theresa Miller, a spokesperson at Prudential Financial Inc.

Speaking on a conference call, Bernard Winograd, executive vice president and COO of Prudential’s U.S.-based businesses, which includes the investment and insurance divisions, said CMBS provided an opportunity for Prudential to “commercialize the credit skills” it has in the commercial mortgage space—as it does with agency lending—but volatility and inefficiency of hedging in the marketplace made the decision to exit “pretty straightforward.”

“There is very little measurable differentiation [in CMBS] between the offerings of a firm that does a good job of underwriting mortgage portfolios and those that are more aggressive,” Winograd said. “While we’ve looked hard for the market environment in which we would get paid for our commercial mortgage underwriting skills, we haven’t found it and we concluded that it was unlikely to arise and, therefore, we have that long-term basic view that we’re not really getting paid for our skills here as much as we were just simply participating in a market that is very unlike what we do in the rest of our investment business where we are managing money for third parties.”

Jim Butler, chairman of global hospitality at the Los Angeles law office of Jeffers, Mangels, Butler & Marmaro, and author ofHotel Law Blog at http://hotellaw.jmbm.com, said the credit crunch for CMBS removed more than $200 billion a year of capital from the commercial real estate markets and synthetics-based CMBS instruments, or CMBX, affects value and liquidity of trillions of dollars of U.S. real estate investments.

“This has all made capital for the hotel industry—and for other real estate asset classes—harder to find and more expensive. Traditional capital sources will not make up the gap in the short term,” Butler said.

However, in Prudential Investment’s April Asset Allocation: Expected Returns for 2008 report, Charles Lowrey, president and CEO of Prudential Investment Management, said investment in all assets require a long-term perspective.

“We continue to publish this piece in the context of 2008’s increased levels of volatility for the simple reason that a view towards the longer term is often lost in such turbulent times. Currently, technicals appear to trump fundamentals and markets seem to trade on rumors that can be self-fulfilling. To weather the current storm we must continue to keep long-term history as an anchor,” Lowrey wrote.

Some industry analysts look for a return to normalcy by the end of this year, but others believe it will take until the middle of 2009 and possibly longer depending on investor confidence in pricing risk.

“Many see the sobering financial markets as a very positive development that will restrain room supply growth and build a much stronger and sustainable base for future recovery,” Butler said.

Prudential Asset Resources continues to service CMBS loans, but Miller would not speculate on selling CMBS loans or CMBS pools in the future. “We are looking across the organization and making decisions about [the] resources we need across the business going forward, and that will shake out over time,” he said.

John Strangfeld, CEO and chairman-elect of Prudential Financial Inc., said he was not satisfied with the company’s first quarter results overall but remained confident in its “strong balance sheet,” adding that Prudential would continue to be “a very large participant in the commercial mortgage marketplace.”

“We have very distinctive origination capabilities and very, very strong underwriting capabilities and we like the asset class,” Strangfeld said.