Commentaries

from Rolfe Winkler:

MBA: CMBS deterioration continues

From the Mortgage Bankers Association:

Delinquency rates continued to increase in the third quarter for most commercial/multifamily mortgage investor groups, according to the Mortgage Bankers Association’s (MBA) Commercial/Multifamily Delinquency Report.

Here's the not-pretty chart from MBA's report:

We don’t need your stinking financing

The New York Fed reports that investors only requested financing for $72.2 million of new CMBS loans through its TALF program.  Since there’s only been one, the $400 million offering from Developers Diversified, it raises an interesting question: would investors prefer to go it alone without perceived government strings attached rather than juice returns through leverage?

Though I’m still skeptical about what this means for the billions of loans that still need to be refinanced, this is a good sign for the CMBS market and one that issuers are sure to notice. Demand is out there whether there’s nonrecourse loans or not.

The drought is (kind of) over!

After months of buildup, Developers Diversified Realty Corp finally sells the first commercial real estate bond in more than a year. At $400 million, it’s hardly a dramatic debut, but it’s a significant first for one of the few markets still jammed since the financial crisis.

From Reuters:

Met with strong investor interest, Developers Diversified was able to price the deal below existing levels for the CMBS issues. Its $323 million AAA-rated five-year notes came at a narrower 1.4 percentage point premium to the five-year interest rate swap benchmark, or a yield of 3.807 percent, market sources said.

Underwriter Goldman Sachs lowered yield premiums from earlier guidance levels of 1.6 to 1.75 percentage points, due to the strong buyer interest.

The yield may seem tiny, but this deal should qualify for the Federal Reserve’s TALF program, which means a healthy dose of leverage will super charge returns. (UPDATE: Taking into account the Fed’s financing, the real return would be 5.9%, according to Barclays CMBS research team.) For the run-down on TALF, check out the Fed’s website here. Oh yeah, and in case anyone forgot, these are non-recourse loans, which means the borrower has  limited downside risk.

This is still just a drop in the bucket for the commercial real estate market. There’s still the looming finance wave to deal with, and many underwater loans out there simply won’t qualify for refinancing. So far the answer has been for banks to amend and extend the terms of the loan, or put another way, delay and pray.

About $570 billion in commercial mortgages are due to be refinanced between 2010 and 2011, according to property researcher Foresight Analytics LLC in Oakland, California. The firm estimates that defaults could cause some $250 billion in commercial real estate losses to the banking sector.

The rock-bottom bar in CMBS

There’s a bit of a bit of buzz surrounding what could be the first CMBS deal in more than a year. Bloomberg is carrying a story about how Goldman Sachs will sell the first bond that would be eligible under the Fed’s TALF program.

But the buzz should be more about how the bar has fallen so low in commercial real estate financing.

From Bloomberg:

Goldman Sachs Group Inc., seeking to take advantage of an untapped Federal Reserve program, may sell the first commercial-mortgage bond since June 2008, backed by a $400 million loan to an Ohio property owner.

The five-year loan to Developers Diversified Realty Corp. made by a unit of the New York-based bank is secured by 28 shopping centers. It will be used to repay debt on those properties and others, and to reduce the outstanding amounts of credit facilities, Developers Diversified said yesterday in a statement.

But the deal has been expected for months. Reuters reporter Al Yoon reported the Developers deal was in the pipeline back in June. That it’s taken this long to get the deal ready is one of the reasons TALF is wrong tool for the job of getting much needed financing to commercial real estate.

Also, for perspective, a $400 million loan is peanuts next to the billions of dollars of loans out there that need to be refinanced. Many of those loans simply won’t qualify for refinancing because their loan to value ratios have been obliterated by the falling value of commercial property.

The TALF option doesn’t seem to be working and hopefully the government’s brain trust is coming up with something better.

CMBS rides again

Well, sort of.

UK supermarket retailer Tesco is planning a 559 million pound securitisation of retail stores and distribution centres.

It’s good to see some kind of CMBS market getting going in Europe given the vast amount of real estate loans that need refinancing in coming years. But, like some of the earlier deals this year, this transaction is just a very tentative toe in the water, rather than a market revival.

Fitch Ratings notes that the deal is entirely expected to be repaid by cashflows derived from Tesco’s rental payments, and the rating agency grades the bonds the same as Tesco (A-). In other words, bond investors aren’t taking much real estate risk —  they’re just taking Tesco credit risk and presumably will get paid a small pick-up over the company’s corporate bonds to compensate for the more complex structure.

from Rolfe Winkler:

Chart of the day: CMBS delinquencies

The delinquency rate for commercial mortgage-backed securities continues to rise.

(Click chart to enlarge in new window)

From Moody's (no link):

Moody's ... latest CMBS Delinquency Tracker (DQT) records the aggregate rate of delinquencies among US CMBS conduit and fusion loans at 3.23%, based on data through the end of August...

"Although the rate of increase has tapered off in the past two months, it is much too early to count on this trend continuing," says Moody's Managing Director Nick Levidy.  "In fact, we expect that the monthly change in the delinquency rate will resume an upward trend over the next several months as troubles compound in the commercial real estate sector."

Of the five core property types tracked by Moody's DQT, the multifamily sector continues to have the highest delinquency rate.   In August delinquencies for this sector were at 5.51%, an increase of 51 basis points since July.

After two months of posting leaps in delinquencies of over 100 basis points, the hotel sector saw its delinquency rate decline in August by 51 basis points to 4.18%.

Retail properties had a 22 basis point increase in delinquencies during August, raising the rate to 3.41%.  Half of the ten largest currently delinquent loans are backed by retail properties.

Office and industrial both had a 21 basis point increase in delinquencies in August.  The office delinquency rate is now 2.01%, the lowest among the five sectors. Office properties, however, generally have long-term leases so the sector"s delinquencies often lag those of the other property types.

Industrial properties are the second best performing property type, with a delinquency rate of 2.46%.

...

By state, Nevada and Michigan continue to post the highest delinquency rates, with Nevada at 8.69% and Michigan at 8.55%.  The rates for both states rose nearly a 100 basis points during August, Nevada having been at 7.71% in July and Michigan at 7.65%.

A dark hour for CMBS

The last week has been a bit of a shocker for Europe’s already crumbling commercial mortgage-backed securities market (CMBS). Investors have had to cope with steep declines in the value of their bonds and a wave of downgrades by rating agencies.

Now, to add insult to injury, there has been a jump in legal and structural issues. Bondholders are having their rights diluted over or taking on fresh liabilities they didn’t even realise they had.

In France a judge this week sided against bondholders who wanted to take control of a Paris-office skyscraper formerly owned by a Lehman Brothers unit. The loan defaulted earlier this year, but a Paris judge approved a safeguard plan proposed by its owners, which include Lehman’s receivers Pricewaterhouse Coopers. Creditors argue that the ruling risks damaging property investment in France.

And in the UK there is the never-ending saga of White Tower 2006-3. This portfolio of elegant city offices was once the property empire of billionaire Simon Halabi, who refinanced them with a CMBS arranged by Soc Gen.

Now the loan has defaulted and the properties are the playthings of a handful of frustrated bondholders and, all of a sudden, the UK tax authorities, which have slapped the companies that own the properties with a withholding tax charge. FT’s Alphaville tells the story here. 

This is all bad, but the worst is probably still to come for bondholders. The highly levered nature of many property loans refinanced during the boom years will likely lead to a truly ghastly default rate as loans mature and can’t be refinanced. The only thing that could save the market is a speedy recovery in commercial real estate and revival in bank lending, hardly a likely prospect.  The return of any kind of CMBS market in Europe looks further away than ever.

The Re-REMIC limit

The repackaging of commercial real estate mortgage-backed securities made a splash in July as banks offered investors panicked by looming ratings downgrades better protection against potential losses. But, it turns out that there’s only been 9 such deals rated by Moody’s, for a total of around $1.2 billion, with Credit Swisse doing three of them.

That’s not a huge amount for a $700 billion market and I suspect the reason is there’s just not that many natural buyers for the riskier, or junior, pieces that need to be sold in a re-REMIC. Repackaging doesn’t magically make the risk go away. What it does is split an existing tranche in two so one piece is better protected while the second is worse off. Who wants to buy the worse off piece when the outlook for commercial real estate is so awful.

Here’s a nice diagram from a recent Moody’s report to show how it works. (HT Alphaville)

From Moody’s:

The most subordinate super-senior tranche in a CMBS transaction is the last super-senior bond to be paid out of principal amortization and recoveries. However, it is pari-passu (or on the same footing) with the other super-senior tranches with regard to the allocation of losses.The super-senior CMBS bonds (A-1 through A-4) usually comprise 70% of the bond structure, and therefore have 30% credit enhancement to absorb any losses in the CMBS loan pool. The resecuritization is usually carved up into senior and junior portions representing 72% and 28% of the resecuritization, respectively. This effectively creates a senior resecuritization tranche with 50% credit support relative to the underlying deal and a junior resecuritization tranche that attaches at 30% credit support and detaches at 50% credit support, again relative to the underlying pool.

Commercial real estate loans grow more distressed

Realpoint, the ratings firm that specializes in bonds backed by commercial real estate properties, is out with its July delinquency report on loans in CMBS deals and it has lots of great data tidbits on the building pressure on distressed loans.

The amount of loans delinquent for three months or more – an indication of extreme distress – now stands at $11.23 billion, up from $9.57 billion in the previous month. What’s interesting about the 90-day plus delinquencies is that they’ve been rising at a much faster clip than say foreclosures and REO (when the property is turned over to the bank). Check out chart on page 9 of the full report here.

It could indicate that a wave of defaults is about to crash.

Part of the reason is special servicers, those charged with helping  borrowers work out a loan when they can no longer stay current on their payments, are still trying to figure out whether these loans are worth saving. Some, presumably will not.

Separately, Frank Innaurato of RealPoint notes that some loans, which are still current on their regular payments, have moved into special servicing anyway in anticipation of refinancing problems on the horizon. Typically, borrowers avoid special servicing unless they’re desperate since it signals a higher likelihood of default.

Here are some of the other key points in the report:

• Based upon an updated trend analysis, we project the delinquency percentage to grow in excess of 6% before year-end 2009 (potentially approaching and surpassing 8% under more heavily stressed scenarios).

• Nearly 54% of delinquent unpaid balance through July 2009 came from transactions issued in 2006 and 2007, with over 28% of all delinquencies found in 2006-issued transactions. When we extend our review to include the 2005 vintage, an additional 16% of total delinquency is found; thus over 70% of CMBS delinquency comes from 2005 to 2007 vintage transactions.

• Throughout 2009, we expect to see continued high delinquency by unpaid balance for these three vintages due to aggressive lending practices prevalent in such years. We also expect to see some loans from the 2008 vintage to show signs of distress and default in cases where pro-forma underwriting assumptions fail to be realized.

British Land’s best assets – its liabilities

British Land is in a good position to take advantage of opportunities. We know because the chairman told us. Why then, is he supposed to be contemplating selling a stake in London office complex Broadgate to Blackstone?

Given how far prices have fallen, the timing looks odd, especially for a company that claims to be in a solid financial position. However, it may make more sense than it appears to. Bank lending and property markets are soft, but the peculiarities of Broadgate’s debt structure may make it worth while for both sides.

Broadgate, now over 20 years old, is showing its age and, at 2.2 billion pounds, is an uncomfortably big lump in British Land’s portfolio. Selling a stake would allow the company to reduce risk and diversify its business.

For a buyer, the attraction lies as much in the quality of Broadgate’s liabilities as those of its assets. The estate may need some work, but it has a state-of-the-art pre-credit crisis debt structure, which any buyer would inherit.

The complex carries 2 billion pounds of debt paying interest of 5 percent, a rate so low that if the loans were quoted, they would stand about 570 million pounds below par. This is equivalent to 61 pence a British Land share, about half of the mark to market gain of 119 pence that British Land recognises on its debt in its triple-net NAV figure.

The stock market may debate whether to recognise this gain, but a private equity firm like Blackstone would certainly value that cheap debt highly.

There is little current equity in Broadgate, and a half share might fetch only about 100 million pounds, but a leverage of about 10 times would produce a supercharged return if the buyer was prepared to wait for property prices to recover. The lack of any loan-to-value covenant in the debt reduces the risk of a breach if markets deteriorate further.