Last year, economists from the Mortgage Bankers Association described the climate for commercial real estate finance as the "perfect calm."

Perhaps that should have been reason to worry. Twelve months later, things look a bit different; to say the least.

"Last year, there probably wasn't anything a lender wouldn't lend on," said John Luka, managing director with Column Financial Inc. during a panel at MBA's Commercial Real Estate Finance/Multifamily Housing Convention and Expo held February 3-6 in Orlando. "Now, there isn't anything a lender will lend on."

The biggest issue facing the commercial real estate finance sector is the commercial mortgage-backed securities (CMBS) market. Estimates are that last year $450 billion in new loan originations occurred, with CMBS accounting for just more than half of that volume--$230 billion. Furthermore, CMBS account for roughly $750 billion of the total $3 billion of outstanding commercial real estate debt. Today, though, estimates are that CMBS volume will drop below $100 billion. The fact that January was the first month with no CMBS issuance didn't help. So the big question, is who is going to come forward and fill that hole?

Life insurance companies--which have lost market share with the rise of CMBS--don't seem to want to step up. Overall, estimates project they will only increase lending volume to $45 billion this year from $40 billion in 2007. The problem is life insurance companies aren't monolines, said Jan Sternin, senior vice president of commercial and multifamily for the Mortgage Bankers Association in an interview with Retail Traffic. Life companies aren't just lenders, but also investors in CMBS bonds. While they might want to increase their loan exposure, they're being held back by the fact that they don't know what some of their bond investments are worth.

"Everything has to come through their investment committee," Sternin says. "When they look at how all their investments are coming together, there is a sense of conservatism right now."

Sternin does think other sources will come forward and they could be new players no one has yet considered. But there is also the sense that the CMBS market will eventually settle because the fundamentals haven't deteriorated as they have for residential mortgage-backed securities. In all, expectations are that the CMBS market will begin to recover in the second half of the year.

In the meantime, the CMBS lockdown has had profound effects on the overall lending environment because of how much the industry has come to rely on securitization. Fundamentally, the problem is that bond investors have been spooked and seem unwilling to stomach CMBS bonds at any price. As a result, banks that had been counting on originating loans then re-packaging them into securities have not been able to do so. There is an estimated $120 billion of such loans languishing on banks' balance sheets. Many are now going through a process of evaluating whether to sell the bonds at a loss or commit to carrying the loans on their balance sheets. Neither option is that appealing. Selling at a loss will hurt banks. But having them on-balance sheet could hurt too. On the one hand, it lowers banks' ability to provide additional lending. Also, if they hold them as part of a "for sale" basket, the loans would have to be marked-to-market. And if the next round of bonds sold is at a deep discount, it could lead to write-downs. However, such write-downs are not likely to match the scale seen in connection with the subprime loans in the residential sector, but they will hurt nonetheless.

On the other hand, the origination side, spreads have been blown out to much higher levels. And lenders are adopting more stringent underwriting standards. According to the Federal Reserve's most recent Senior Loan Officer Survey, the percentage of banks reporting tightening standards is at a record high across all loan types.

One of the most vexing parts of the current credit crunch is that commercial real estate lenders are facing problems that don't stem from the properties themselves, but because of the larger capital markets events that shook Wall Street the past six months. The spread of the subprime crisis into a broader issue of liquidity has touched the entire banking sector. If tensions are a bit high here, it is because the problems in the residential real estate sector have tainted all things real estate, leading to distrust among debt investors about the quality of any kind of securitized mortgages.

But that's the biggest reason for their optimism.

"The fundamentals are very sound," Kieran Quinn, chairman of Column Financial and 2008 Chairman of MBA said during a press lunch. "You can find some ill-conceived loans and there are losses coming because AAA bond spreads are widening. But overall, things aren't that bad."

To be sure, there is an expectation that defaults and delinquencies will rise and that 2006 and 2007 vintage loans had underwriting standards that were too loose. But defaults and delinquencies have a huge margin for moving up before they hit the levels seen in the early 1990s. Today, commercial loan delinquencies are less than 1 percent; whereas, in the early 1990s, those delinquencies hit 12 percent. Delinquencies and defaults could triple from current levels before posing a real threat. But, there is little reason to believe they could ever reach the levels the residential sector is seeing today.

-- David Bodamer