Commentaries

from Rolfe Winkler:

Ugly CRE charts

From the Mortgage Bankers Association's Quarterly Data Book:

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.

Commercial property borrowers falling short

Commercial real estate loan delinquencies are on the rise again, and September’s increase is the largest ever, according to Moody’s Investors Service’s latest tally of those loans included in CMBS deals.

Delinquencies stand at 3.64%, up from 0.54% a year ago and 0.41 percentage points higher than August. The hotel sector showed the biggest increase in late payments, up 0.79 ppt to 4.97%. The multi-family housing sector now stands at 6.09% – the highest of any property type.

In terms of region, the South has been the hardest hit followed by the Midwest.

Commercial real estate death watch – Capmark

What do you get when you put a U.S. automaker, a leveraged buyout and commercial real estate together – a soon-to-be bankrupt company. Caroline Humer of Reuters reports that that Capmark – formerly the commercial real estate business of GM financing arm GMAC – is teetering on the brink of bankruptcy, with the final blow coming possibly by the end of next week?

The company, which owns a bank that will continue to operate while it is in court, is in negotiations with lenders, bondholders and the Federal Deposit Insurance Company that will result in a filing by the end of October at the latest, the source said.

They are working on details of a debt-for-equity swap that will take place to bring the company back out of bankruptcy, he said. It is not certain how long the court process could take.

Those that swooped in and bought the unit in March of 2006 in an LBO may be out of luck if the company files for bankruptcy.

Kohlberg Kravis Roberts & Co KKR.UL, Goldman Sachs Group (GS.N) and Five Mile Capital, which bought Capmark in March 2006 for $1.5 billion in cash plus more than $7 billion in debt at the peak of the housing market, will not receive payment through the bankruptcy.

The source said the company will belong to its creditor group, which is made up of more than 50 banks and more than 50 hedge funds among others. The lead banks are Citigroup’s (C.N) Citibank and JPMorgan Chase (JPM.N).

There’s also a Warren Buffett angle to this tale. Reuters said Capmark has will sell the company’s loan servicing and mortgage business to Berkshire Hathaway and Leucadia National for $490 million in what would be a 363 bankruptcy when good assets are separated from the bad and then spun out into a stronger standalone.

It’s not surprising that a commercial real estate financing company is in trouble given the woes in the sector. Property prices are down between 35%-40%,  a good chunk of borrowers are underwater and new financing is almost non-existent. The government’s TALF program has done little so far to jump start the CMBS market, with just a measly $400 million deal from Developers Diversified the only beacon of hope so far.

Bernanke’s Hester Street home

The Federal Reserve may not want to crow about the half-empty giant shopping mall it now owns in Oklahoma City by virture of its hastily-arranged rescue of Bear Stearns. But at least one other commercial real estate deal that the Fed picked up from Bear appears to be in better shape.

One loan now in the Fed’s portfolio is a mortgage Bear made to the developer of an upscale condominium building in lower Manhattan called The Machinery Exchange. The 14-unit complex at the corner of Hester and Baxter streets is located on the edge of Chinatown and got a favorable write-up from The New York Times in 2007 because of its architectural style.

The developers bought the 94-year-old seven-story former machine warehouse in 2005 for $10 million. Real estate records indicate that Bear provided the financing for that deal. The developers also raised an additional $25 million in construction financing from other investors–although it’s not clear if Bear was part of that transaction.

Either way, it appears the project, where some units were priced at between $1 million and $5 million, is in fairly good shape. The website for renovated building says no units are availalble–usually a sign that all of the apartments were sold.

The hunt continues for the rest of Bear’s commercial real estate projects that landed in the Fed’s lap.

German covered bonds under scrutiny

Fitch Ratings seems to be getting nervous about the amount of commercial real estate loans included in German banks’ covered bond pools.

The agency today affirmed 17 covered bond programs as part of a review, but kept nine German banks programs `under analysis.’ The rating firm now wants more information from the banks on the kind of real estate debt they use as collateral for their covered bonds.

Covered bonds are a kind of secured debt issued by banks in which bondholders have recourse against both the issuer and a segregated pool of assets, such as mortgage or public sector loans.  German banks include large amounts of commercial real estate debt in the covered bond pools, alongside more granular and lower risk residential and public sector loans. Investors were happy to keep funding the banks and rating agencies gave the debt AAA ratings because the loans included in cover pools were required by law to be backed by a minimum amount of collateral, giving the loan a cushion in case the borrower defaulted.

The rules state that loans can only be included in covered bond pools if the principal is no more than 60 percent of the value of the property. However, given the sharp fall in commercial property values in recent years, Fitch is no longer comfortable relying on just this rule.

Fitch said today in a report:

“Whereas so far, Fitch considered that the mortgage lending value threshold set at 60% by the German Pfandbrief Act provided adequate protection against expected losses evening higher stress scenarios, the agency recognises commercial real estate risks in German cover pools need to be assessed more precisely’’

The rating firm has given banks three months to gather all the necessary data it needs to analyse the loans. There’s no mention of downgrades in Fitch’s report., though if the firm does decide the bonds aren’t adequately covered by the current cover pool, it could mean banks will have to stump up more collateral to support the deals’ ratings.

from Rolfe Winkler:

Moody’s: CRE prices resume descent

Last month commercial real estate prices took a bit of a breather, falling just 1% after seeing prices fall 9% from March to April and an additional 8% from April to May. Those are fairly stunning rates of decline. In July, the descent picked up steam again, falling 5.1% compared to June.

Commercial real estate prices...renewed steep declines and low transaction volume in July... The [Moody's/REAL Commercial Property Price Index] was down 5.1% from June after having declined by only 1% the prior month.  It is now 30.8% below what it was a year earlier and 38.7% below the peak measured in October of 2007.

Overall market transaction volume continued the pattern of calendar 2009.  "The market has averaged about 375 sales per month for the seven months in 2009," said Moody"s Managing Director Nick Levidy. "Over the same time period in 2008, sales were averaging nearly 1,100 a month."

So much for improving second derivatives, at least on the CRE side.

For residential, you can see the market appears to have stabilized this summer. But that's thanks to government support. Eventually support will go away and residential prices will likely turn back down.

As always, I want to include a caveat with the chart above. Comparing these two indices is difficult due to the number of data points available. The Case-Shiller index draws on millions of transactions over time. The Moody's/REAL index has far fewer, just 300 this month.

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.

Loans of concern

“Loans of concern” has the same ominous ring as the phrase “persons of interest” when uttered by law enforcement officials investigating a murder.

The corpse in this instance is the commercial real estate market, and Fitch Ratings has the latest indication of its morbid condition.

Fitch reports that it has added 432 commerical real estate loans totaling $5.2 billion to its designation of “Loans of Concern.” The 7 percent increase from June through August, means that $80.7 billion of U.S. commercial real estate loans have either deteriorated or defaulted — that is 17 percent of the total U.S. CMBS portfolio rated by Fitch.