Commercial mortgage-backed securities shops saw profitability plunge by about one third in 2005 due to increased competition between lenders and a number of new entrants. There was a record-breaking $160 billion of new issuance last year, up from $93 billion in 2004, and originators are reporting that competition for new business has been cutthroat. "I would say that profitability did contract in 2005 as a result of increased competition," said Ken Cohen, managing director at Lehman Brothers. "Many shops are working for less money but making up for it on volume and hopefully that is a trend that won't continue."

In the past, conduit lenders often made about 2-3% on individual loans but this has dropped to about 1% because of spread compression and higher break even points executives estimated.

"In 2003, short-term interest rates came in and we were able to earn the interest rate carry. Spreads on bonds and subordination levels also came in," said Kieran Quinn, president of Column Financial. "But by the second half of 2005, we had done all we could on subordination levels; there were 20 of us competing and it became so competitive that a cream puff vanilla deal would see a margin of less than 1%."

Jon Vaccaro, global head of commercial real estate at Deutsche Bank, believes the decline in profitability and the boom in origination volume in 2005 were a direct result of the commoditization of the real estate debt markets. "I think that there was a common belief among real estate professionals that real estate debt was not supposed to be something that could be commoditized. Real property is different-there are no two leases that are the same, property and market locations are unique, property conditions and maintenance vary and ownership or sponsorship is very specific," he said. "We really never thought that the pricing of loans could be commoditized like single-family mortgages or credit cards. At some point we will find out if it is really commoditized or if it is a unique asset class that has to be tailored."

Liquidity has been strong and is expected to continue to be so in the coming year. Lenders said that companies that offer a multitude of products such as CMBS loans, construction loans, bridge loans, b-notes and mezzanine debt are better positioned to perform well in the current competitive environment. In addition, strong relationships with borrowers will lead to more repeat business.

The consensus is that 2006 will be another strong origination year but executives are divided over whether it will top 2005. "Most of our competitors are forecasting that there will be 20% more volume in 2006. But I believe that we will be in a higher interest rate environment and originations will be flat," Vaccaro said. He added that there will be a substantial number of refinance opportunities of 1996-1998 collateral.