July 1, 2013 - By Jay Rollins
The Bernanke Bubble
As appeared in the July 2013 issue of Institutional Investor
On an overall, macro basis, the current economic environment is not sustainable and there is a disconnect between the “Fed-driven economy” and the real economy. The Federal Reserve’s easy economic policy of continued low interest rates makes it difficult to know what is real and what is fictitious.
The Bernanke Bubble
What Alan Greenspan did for housing values, Ben Bernanke is doing for commercial assets that have any income stream. Any asset with a predictable income stream (real estate included} is being overvalued, due to the markets thirst for yield. Core real estate is now being viewed as a proxy for the 10-year Treasury and investors are willing to accept yields in the 4-5% range on properties with strong cash flow.
This hunger for yield has forced investors into more equities and riskier assets, as evidence by the increase in the stock market. I am not a believer in this thesis, as there is disconnect between the market fundamentals and the monetary policy that is driving the market.
New CMBS Issuance
The market is being driven by the Bernanke Bubble, as the aforementioned push for yield has made CMBS very viable.
Asset fundamentals have only improved marginally, yet rates are historically low, which is driving up CMBS volume as investors seek out yield. Ten-year, AAA bonds are trading for less than 3%.
The questions are:
Will rates stay low long enough to keep this business viable?
Will the 25 CMBS lenders run out of product to sell investors or will they again “stretch” for product, which was the beginning of the end of the last CMBS cycle?
Maturity Defaults Continue
Lenders are now more aggressively recognizing and dealing with their maturity defaults, as legacy financial institutions gradually are getting healthier. This is creating more note sales, more REO sales and more borrower DPOs. Middle market borrowers, however, lack the liquidity to take advantage of these discounted payoffs, and must turn to private capital for assistance.
As predicted in 2009, we never experienced thousands of bank failures (RTC Circa 1992). Instead we have seen banks saved by the Federal Reserve’s easy monetary policy.
Question: Now what’s next for banks?
Answer: A slow continual shedding of non-performing assets, primarily resulting from maturity defaults combined with an extended period of bank consolidation. This combination of consolidation and maturity defaults will continue to provide opportunities for private capital.
Lack of Liquidity in the Middle Market
Middle market commercial real estate sponsors are still recovering financially from the real estate downturn. Many have legacy credit issues, which makes it difficult for them to obtain financing from traditional lenders. Traditional sources of middle market capital remain constrained and the capital raising environment remains difficult.
The middle market will be where excellent opportunities exist to deploy capital. This capital may be structured as:
- Participating Debt
- Mezzanine Loans
- Preferred Equity (Preferably unleveraged)
- Pari Passu Equity