The changing face of commercial property lenders

US commercial real estate prices have firmed up recently although the recovery remains uneven across the various sectors.

Source: Real Capital Analytics

Improvements in pricing are giving rise to higher deal volumes as investors chase yield-generating assets. Anecdotal evidence suggests that commercial property transaction volume remains robust for the current quarter. Commercial real estate investing is popular once again.

Source: Real Capital Analytics (note: the big pop in Q4 of 2012 was tax-related)

On the other hand, the amount of commercial real estate mortgage backed securities (CMBS) outstanding is still declining after peaking in 2008. Total balances are now at the lowest levels in seven years.

Source: SIFMA

Something is off. We know that property purchases are almost always leveraged (very few buy commercial properties with cash - the rental yield is just too low). So who is providing the mortgage financing? In the past many of the large banks would arrange these loans, pool them across multiple properties, and then sell them as CMBS. The securities would be sold in tranches, with cash from mortgage payments following a predetermined "waterfall" (senior tranche would get paid first and so on). It seems that in recent years the use of CMBS as a financing tool has become far less prevalent even as commercial property deal volumes pick up.

Bloomberg: - ... sales of commercial-mortgage backed bonds are falling short of predictions for the best year since 2007: Issuance slumped to $14.6 billion from $20 billion in the same period last year, according to data compiled by Bloomberg. Bank of America Corp. cut its forecast last week for deals tied to single loans, typically backed by the higher-quality properties that insurers target, as sales plunged 66 percent from last year’s record $9.1 billion.

Part of the trend has to do with securitization being out of favor in general. Banks for example can't hold material amounts of CMBS on their books for regulatory reasons but can on the other hand hold a portfolio of real estate loans. It's the same type of risk but the "optics" are different.

Another reason is competition for direct loan assets. Many institutional investors have been getting into direct investing and direct lending. Insurance firms for example often act like bankers these days: competing for rates, arranging loans, charging fees, etc. Except they are funding assets with premiums from insurance sales rather than with deposits. And many of these institutions are so hungry for yield that they undercut banks on pricing. Great for property buyers, bad for the CMBS market.

Bloomberg: - Insurers are offering 10-year loans with interest rates as low as about 4 percent, compared with 4.9 percent on new debt that will be packaged into bonds, according to Alan Todd, a debt analyst at Bank of America. Insurers are increasing those investments because they performed well for them during the credit crisis and its aftermath, Woodwell said.
...
MetLife, the largest U.S. life insurer, has increasingly turned to real estate to bolster profits and support long-term obligations as the Federal Reserve holds interest rates close to zero for more than five years. Last year, MetLife boosted lending for commercial properties 19 percent to a record $11.5 billion, funding loans including $450 million to Shops at Columbus Circle in the Time Warner Center in Manhattan and $500 million against its own New York headquarters at 1095 Avenue of the America.

Even some pensions are moving into direct lending as this "shadow banking" market picks up steam. So if you are looking for a mortgage to fund your commercial property purchase, these days your banker won't necessarily be a bank.

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From our sponsor:

Six observations about index CDS markets

Once again it's time to clear up some misperceptions about the CDS markets. In particular, let's take a look at CDS index trading. The chart below shows one-month daily trading volume averages for the various CDS indices.

1-month daily average CDS index volumes ($bn; source: JPMorgan/MarkIt) 

Here are some observations:

1. CDS index trading is dominated by corporate unsecured credit, particularly investment garde: IG CDX and iTraxx Main.

2. European corporate credit trading is dominated by banks (followed by telecoms), while the US actively traded credits tend to be non-banking firms. That's why iTraxx Sen Fin (senior EU bank credits) is so popular. Barclays and Banco Bilbao Vizcaya Argentaria for example have been at the "top of the charts" in Europe, while the US market shows the highest volumes in GE and HP.

3. Sovereign indices, such as SovX are a fraction of the corporate market. Emerging markets CDX has more volume than the Western European SovX.

4. The market for CDS on senior secured debt (corporate loans), the so-called LCDX, is dead. This market was popular in 2007/8 when people sold protection on LCDX and bought protection on HY CDX thinking that in a crisis secured paper will outperform unsecured bonds - which would be reflected in the spread between the two. But these investors were wrong, as LCDX protection widened out just as fast as HY CDX as leveraged loans took a major beating. Since then the market on loan CDS has all but disappeared.

5. The municipal bond CDS index, MCDX never really took off and shows little improvement. As much as Markit wants this index to be used to hedge municipal bond portfolios, that is just not happening on any material scale.

6. Asset backed indices are mostly the left-over structures from the pre-crisis era. These include ABX (see discussion) and CMBX. They are used for spec trading as well as to hedge ABS and mortgage books. But even in that space users prefer corporate credit indices such as CDX IG and CDX HY to hedge their portfolios. Liquidity trumps increased basis risk these days.

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US banks still cutting commercial real estate exposure

Once in a while an article on commercial real estate appears that seems to point to improvements in the commercial real estate (CRE) credit conditions.

CoStar Group: - While a host of banks are still working through mounds of distressed commercial real estate assets, a number have decided the time is right to jump back in. Those banks that are lending again see lower risk owner-occupied properties and multifamily properties as preferred targets. But with lenders focusing on the same 'safe shelter' property sectors, it is creating widespread competition for the better-quality borrowers in those areas.

Is there really a thaw in US CRE credit or are banks simply rotating into a higher quality portfolio? The answer can be seen in the latest data from the Fed. It points to an ongoing and almost a linear decline in the overall CRE lending by large US banks.

Commercial real estate loans as percentage of large US banks' total bank credit
(weekly data, source: the Fed)

With CMBS maturity wall still looming, and a shaky macroeconomic backdrop, large US commercial banks are in no hurry to get back into CRE lending. Sure there are some interesting opportunities for banks, particularly in the multifamily sector that has been doing well. But as a whole, banks are rotating out of the sector at an almost constant rate since 2009.

That is why the Fed's sale of Maiden Lane III CMBS CDO portfolio had to be executed quickly - there is no reason the Fed should carry this risk on its balance sheet longer than necessary. Nationally the CRE market is still in a persistent deleveraging mode.

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The Fed needs to move quickly on Maiden Lane III CMBS asset sale

IFR/Reuters published an article yesterday on a group of banks bidding for the commercial real estate assets of Maiden Lane III (one of the two AIG rescue facilities). Not to be outdone, Bloomberg/Businessweek did their own story today. It's important to note (IFR didn't make it clear) that the bid is only for the CMBS portion of the portfolio (two CDOs).

Source: NY Fed

IFR/Reuters: - Citi, Goldman and Credit Suisse are joining forces to submit a combined bid for the bonds, which they believe will be more competitive than acting individually, sources familiar with the plan said on Monday.

The debt in the Maiden Lane III portfolio is known as the MAX CDOS, and the deals were originally arranged by Deutsche Bank. 

Blackrock, who is managing this portfolio has been criticized for not extracting the full value for the Fed by entertaining this group bid.

IFR/Reuters: - “If Blackrock really wanted to recoup maximum proceeds for the taxpayer, they’d look into collapsing the CDO themselves, and auctioning off the individual bonds,” said Adam Murphy, president of Empirasign Strategies in New York, which tracks trading in securitized debt.

"Collapsing the CDO" however is easier said than done. In order to sell the underlying portfolio of CMBS securities held as collateral in the two CDO structures, one needs to control the CDO liabilities.

IFR/Reuters: Deutsche Bank already owns junior tranches of the collateralized debt obligation (CDO) on offer and if it also purchases the senior parts it may hold majority ownership in the structure.

Therefore whoever wants to sell off the individual bonds first needs to buy the junior tranches from Deutsche. But that wouldn't be the end of it. There is also a rate swap (which has seniority in such deals) that needs to be terminated with Barclays before collateral could be unlocked.

Businessweek: - The CDOs could be sold intact or broken into pieces. An interest-rate swap contract with Barclays would need to be paid out to access the underlying bonds, eating into profits, according to JPMorgan Chase & Co. (JPM) (JPM) Deutsche Bank, which owns the most junior slices of the CDOs, would need to be bought out to break up the CDO, according to people familiar with the deals.

Barclays (actually the old Lehman people) even suggested that instead of selling the collateral, they would actually "re-tranche" the CDO to make the senior tranches better quality (more subordination) - "putting the humpty dumpty together again". That may make these bonds more attractive to institutional buyers, but would take time.

The Fed's exposure to Maiden Lane III has been declining as the interest payments from the deal are used to pay down the original loan against the facility.

Source: NY Fed

Once that's paid off, AIG gets its loan paid and the remaining cash flows are all profit for the Fed (shared in part with AIG). However it is important for the Fed to move quickly.  Here are the reasons.

1. Trying to sell the collateral may not necessarily get the best price because the Fed/Blackrock would be dribbling out 103 separate CMBS bonds. That in turn could push down the market for this type of paper and may even spill over into other markets as was the case with Maiden Lane II. And to unlock the collateral, deals would need to be struck with Barclays and Deutsche. These negotiations may take more time.

2. Under the Volcker rule and with Basle III, the dealers will be allowed to hold far less inventory, making it much more difficult for them to take down a big slug of structured credit paper. It would be easier to do this trade before these new regulations are in place.

3. If we have another major market disruption driven by events in Europe, nobody is going to touch this paper for a while.

4. There is a risk that the US economy takes a turn for the worse. That would put further pressure on the commercial property markets, potentially impairing more of the CMBS paper.

The sooner the Fed unloads this wonderful portfolio the better. Because next on the sell list, after the CMBS CDOs, are the Maiden Lane III ABS CDO bonds of much greater size.

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The CMBS maturity wall is here

The latest report from Fitch discusses the timing of pain taken across the structured products universe. The charts below show the number of impairments and the impairment rate for each year. Here are the three major categories of structured products.

1. RMBS: The pain in Residential Mortgage Backed Securities was taken relatively early, and it was swift and brutal. The impairment rate shot above 40% in 08 and 09.

RMBS (source: Fitch)

2. Structured Credit: CDOs and CLOs took a bit longer to play out. But impairment in CDOs in particular clearly played out.

Structured Credit (source: Fitch) 

3. Which brings us to CMBS. Back in 2009 we discussed the looming CMBS maturity wall. Well that wall is here now, and unlike the previous two categories, we still have some ways to go on CMBS to get over the impairment peak.

CMBS (source: Fitch) 

Commercial property markets have stabilized a bit, back to 2003 levels (as the chart below shows), allowing some sales and refinancing. But this maturity wall will take some time to work out, while it continues to put downward pressure on various commercial property markets in the US.

Moodys/REAL Commercial Property Price Index (CPPI) - Methodology developed at MIT's Center for Real Estate (Source: MIT)

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Hotel properties struggling nationally

The recovery in US commercial real estate continues to be spotty. Rental residential properties are doing reasonably well, although delinquencies are still high in Florida and other parts of the SE. One property type that is still a problem in this market is hospitality. The map below shows the distribution of REO properties (hotels that are now owned by the lenders).

% REO Hotels (source: Bloomberg)

Of course REO levels is a "backward-looking" indicator, given the amount of time it took banks to become the proud owners of dysfunctional hotels. What makes this particularly disconcerting is the percentage of hotel properties that are on the problem watch list. This measure counts properties that may not be able to meet their loan obligations, a more "forward-looking" indicator.

% Hotels on watch list (source: Bloomberg)

The problem areas are distributed nationally with Milwaukee, Sacramento, Hartford, Oklahoma City, and Raleigh being the five worst hit regions for hotel properties. This points to a substantial and potentially ongoing overcapacity in the hospitality space at the national level.

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TALF's progress painfully slow

The Fed's TALF program continues to struggle. It's a good sign for the taxpayer because the Fed's exposure to the program is quite modest relative to it's overall balance sheet. Exposure to AIG (including the Maiden Lane portfolios) is significantly larger than TALF for example. But it's bad news for the consumer, as credit cards and auto loans availability have been helped only marginally by the program.





The non-CMBS component of TALF issuance has been on a decline. That means that fewer participants are willing to take ABS equity risk for the investment returns they expect. Banks don't want to increase exposure to the US consumer, and not enough private investors want to be involved either.





The CMBS program is also fairly weak. The old notion of "give them leverage and they will come" did not play out. No new CMBS deals have been done under TALF. Only existing deals have been financed - someone who held old CMBS "AAA" tranches was able to borrow against them from the Fed. But this is not making a dent in the overall $700 billion CMBS market.




Given it's limited effectiveness, it is entirely possible the Fed will stick to the deadlines currently in place and terminate the program in the next few months:

The Fed: The facility will cease making loans collateralized by newly issued CMBS on June 30, 2010, and loans collateralized by all other types of TALF-eligible newly issued and legacy ABS on March 31, 2010, unless the Board of Governors extends the facility.

No joy for US commercial real estate

Here is a great picture of the state of the commercial real estate markets in the US. It shows the Moody's commercial real estate price index and the delinquency rates on commercial mortgages.


source: Moody's

In addition, sales of commercial properties have dropped off the cliff as financing disappeared (less than 5% of the volume for the same time in 07). But here comes China to the rescue with the CIC sovereign wealth fund. It's not going to help existing property owners and lenders, but it may create a market for distressed commercial real estate properties.

WSJ: ...in order to achieve any meaningful diversification in its portfolio, the fund would need to set aside between $4 billion and $10 billion to global property investments in the next year and a half, estimates Michael McCormack, an executive director at Z-Ben Advisors, a consulting firm in Shanghai. By 2014, he projects that CIC's U.S. property investments alone could amount to more than $20 billion.

The GGP case changed the rules of engagement for securitization

A recent ruling in the case of the defaulted General Growth Properties (GGP) has sent shock waves through the securitization markets. The ruling placed into question the strength of what's called "bankruptcy remote" entities. These entities are set up to ring fence the assets that represent the collateral pool for structured debt. One key reason for this requirement is to protect the debt holders' collateral from being dragged into bankruptcy if the equity holder defaults.

For example, consider a hedge fund that wants to leverage some assets. It would create a Special Purpose Entity (SPE) to purchase assets (loans, bonds, etc.) The hedge fund then contributes equity to the SPE. The leverage would come from senior lenders who are comfortable with the pool of assets in the SPE as collateral, but want nothing to do with the hedge fund. Their concern obviously is that if the hedge fund blows up, the fund's creditors will go after the assets in the SPE, even if the SPE itself has not defaulted and has plenty of asset coverage.

Using Delaware law allowed structured finance gurus to ring fence the SPE. A bank structuring the deal would work with the equity holders (in this case the hedge fund) to appoint independent directors and a trustee. If the hedge fund defaults, the structured senior debt holders and the trustee would make sure nobody can touch the collateral (including cash) in the SPE.

The GGP case seems to have changed the rules of engagement with respect to Delaware SPEs. In this particular case, the SPEs in question were GGP's property holdings that used CMBS financing. First let's take a quick look at a typical CMBS structure with respect to the equity holders and the SPEs:




Usually each property is held in an SPE which gets a mortgage on the property from the CMBS pool. These SPEs have independent directors and have been viewed as "bankruptcy remote". The mortgage provider is the CMBS SPE (a separete entity), which holds a pool of such mortgages on multiple properties (usually geographically diversified). To finance these mortgages, it issues structured notes that are tranched based on seniority. Cash flows (mortgage payments) generally follow a "waterfall" prescribed by the CMBS indenture, with senior notes getting priority to these cash flows.

In many cases a credit worthy equity owner will provide some form of a limited non-recourse guarantee to the mortgage lender. That creates additional credit support to the CMBS structure, reducing the financing cost to the property owner. This credit support however was a negative when the judge was considering the issue of "bankruptcy remoteness". The ruling allowed the bankrupt GGP to go after the properties and cash held in these SPEs, exposing the weakness in the Delaware SPE structure. The paper below discusses the weaknesses of the Delaware SPEs, particularly as it relates to CMBS.

The key issue was that the independent directors of the SPEs as well as the management (which now were the direct creditors of GGP) were allowed to consider not just the interests of the creditors, but of the equity holders when deciding about the fate of the SPEs. GGP creditors wanted to drag the SPEs into bankruptcy and they got the directors to vote their way. Interestingly enough GGP fired existing SPE directors and appointed new ones (that would be more cooperative) shortly before they filed for Chapter 11. The explanation was that the new directors knew more about commercial real estate.

But how can you force an entity into bankruptcy if it is current on its debt and doesn’t have to refinance for up to three years, as was the case with these SPEs? GGP argued that these entities will be bankrupt anyway when they have to refinance their balloon mortgages. This argument is in fact valid because of the wall of commercial real estate debt maturing in a few years (see looming balloon risk).

In addition, the argument was that the current state of GGP (as the SPEs’ affiliate), should be considered. In order to preserve value, the SPEs need to file now, rather than wait until their debt matures. The judge accepted this argument and allowed to have the SPEs file for Chapter 11.

That of course was a shocker to the CMBS debt holders, because their collateral was now compromised. Some legal scholars have argued that GGP is an isolated case and new cases (which are definitely coming) will prove that Delaware law works for bankruptcy remote SPEs. But given the sad state of the securitization markets, nobody wants to take a chance, and structurers are quickly moving away from Delaware. The jurisdiction of choice is now the Cayman Islands, where directors (when they get back from the beach) will side with the debt holders. And hedge funds that want to obtain non-recourse leverage (to the extent it's available) even for their onshore funds, will be setting up Cayman SPEs.

The realities of commercial real estate loan market

The commercial real estate loan market is facing two nasty headwinds. The first one, which is more visible, is the maturity wall of commercial mortgages (many of which have been securitized via CMBS). Concentrated maturities with balloon type principal payments will make it that much more difficult to refinance these loans.

The second issue is the rise in payment delinquencies. The chart below shows the recent trend as well as a forecast by Real Estate Econometrics, projecting delinquencies to hit 5.4% in a couple of years.



It's not such a scary number relative to the residential mortgages delinquency rates, but it's devastating for the commercial property market. In fact the Beige Book survey that came out today pointed to commercial real estate market as a continuing drag of the economy:

The nation's commercial real estate market is still declining from sea to sea. All 12 districts report weak demand, and a mix of rising vacancies, falling rents, rent concessions and postponed property improvements. (Forbes)

Of course the rating agencies are playing catch-up, with a rapid fire downgrades of CMBS tranches. Here is the ratings transition matrix from Moody's just for the week.



And this is what Moody's had to say in their recent report (about lagging just a bit behind the market):

The review reflects adjustments we are making to two key inputs to our CMBS rating model -- stressed capitalization rates and property cash flows. We generally rated conduit and fusion transactions from 2006 through 2008 to an expected loss of about 2%, but we now expect that deals from these vintages will experience losses of approximately 5% on average.

These headwinds will have a significant drag on banks' performance, given that they hold $1.087 trillion (according to the Fed) of commercial real estate loans. On average it is about 15% of their loan portfolios, but for many regional banks who are concentrated in commercial real estate, this is even more of an issue.

CMBS TALF is starting to ramp up

In our previous discussion on CMBS called CMBS balloon risk looming, we covered the refinancing risk for commercial mortgages. These mortgages form the collateral pools for CMBS bonds, creating significant risk that these securities will default on part or all of their principal. That risk however varies dramatically based on the seniority of CMBS tranches.

Here we refer to CMBS securities in terms of ratings, which represent the level of seniority (the actual ratings themselves are fairly meaningless for CMBS at this point). The chart below shows spreads (from Morgan Stanley) for the highest seniority tranche (super-senior AAA) and a junior tranche (BBB).

Super-senior AAA and BBB spreads over US Treasuries (spreads are on two different scales - see left and right y-axis)


Since the start of the financial crisis, the spreads have blown out on these securities in part because of increasing delinquencies, but mostly due to refinancing risk. However as the credit markets stated rallying, the senor tranche spread has narrowed, while the junior tranche stayed at distressed levels. The junior tranche is priced based on coupons it may pay, assuming that it will not pay any of it's principal. In fact in some instances these tranches are expected to pay only a portion of their expected coupons.

The super-senior AAA is different. Even in an environment of highly depressed real estate values, the tranche (for many CMBS deals) is expected to pay a significant portion of it's principal due to substantial subordination "beneath" the tranche. When properties are liquidated (because mortgages can not be refinanced), there may be enough to pay down the AAA, but the market does not expect there to be much left to pay the junior tranches. The diagram below illustrates how the market views the risk on these bonds:



Some view the most senior tranches of CMBS as a potential investment opportunity. Even if not all the principal will be recovered (though some market participants think many of the senior tranches are money good), the discount (or effective spread) may justify the investment. But 500 basis points over Treasuries for securities that are 5-10 years in maturity is not a great return for many investors who are taking this risk.

But the Fed came to the rescue to bump up the return, by providing leverage on the senior CMBS tranches via TALF. This is the riskiest component of the TALF program for the Fed (and that's why the leverage on CMBS is lower) Thus CMBS TALF has started doing some volume.



However, this is still a drop in the bucket, given the $700 billion CMBS market. Also these TALF transactions are secondary CMBS only. The big question remains, is whether TALF will stimulate any private financing of new properties. So far new CMBS activity is nearly non-existent, but there are some deals in the works to take advantage of TALF. From the WSJ:

Vornado Realty Trust, one of the U.S.'s largest real-estate investment trusts, is planning on raising between $550 million and $600 million through a bond sale that would qualify for a key government program aimed at resuscitating the commercial-property market, according to people familiar with the matter.

Participants are banking on a larger TALF operation in September to move some of the massive existing inventory and possibly do some primary deals.

TALF leverage overview

A number of Sober Look readers have asked to see the leverage levels the Fed is providing via TALF. The leverage varies by maturity and by asset class. There are several ways to show leverage - here we show it as "assets to equity" ratio. That is if you invest a dollar, how many dollars worth of assets you would control. The maximum leverage permitted under TALF is 20 times ($1 buys you $20 of assets) on something like a short-term prime credit card portfolio. The leverage permitted is based on the Fed's view of how risky the assets are. For example auto leases are deemed riskier than auto loans (given the resale risk.)

Small business loans and government guaranteed student loans have only two leverage categories - less than 5 years and greater than 5 years. All other assets have the full spectrum of maturities vs. leverage. The chart below shows that as maturities get shorter, an investor can get incrementally more leverage. Each maturity bucket (term- in years) is shown as a different color.

We show TALF CMBS leverage separately, since it's almost a separate program. Maximum leverage on CMBS is 6.7 times.

Note that on "legacy" CMBS, the leverage is smaller, since the paper is valued below par. So for a senior note that trades at 75c on the dollar, the leverage would be 75% of what's shown in the chart above.

CMBS balloon risk looming

A number of readers have asked about the "commercial mortgage maturity wall", the maturity profile of commercial real estate loans securitized with CMBS - alternatively called CMBS refinancing risk or "CMBS Balloon Risk". Note that this excludes commercial loans that haven't been securitized. Here is the latest chart:



"With ext" are those loans that can be extended one or several times. "ARD" stands for "anticipated repayment date" loan. Unlike a typical balloon commercial mortgage, not repaying the balance on ARD does not constitute an event of default. Instead the borrower is forced into a higher rate and high principal paydowns to accelerate amortization.

The rest are standard balloon loans. At maturity you have two choices: refinance or sell the property. Neither works in this environment. And TALF won't be around when the loans mature. This chart alone is an indication of serious troubles for commercial real estate in the near future. So don't launch your distressed real estate fund just yet - wait a couple of years.

Also some readers have asked for a CMBS primer. The document below from Nomura is a good overview of CMBS and synthetic CMBS.

First CMBS TALF operation is a drop in the bucket

Following up on our post CMBS, the latest evidence of pain, the results are out for the first TALF CMBS operation. The NY FED agreed to lend $669 million against legacy CMBS paper as collateral. This may seem like a large number, but it will have no impact on the overall market.



Note that the first non-CMBS TALF operation took in almost $5 billion for auto and credit card collateral, and that was considered a failure of the program.

TALF is the last hope to get some stability into the commercial real estate mortgage market, but at this slow pace the program will be ineffective.

CMBS, the latest evidence of pain

From CRENews.com

In total, 12,853 loans with a balance of $158.6 billion are on watchlists. They were placed there for various reasons, chief among them is that they failed certain objective financial tests, namely those for debt-service coverage levels.

Loans originated in 2006 and 2007 account for an overwhelming share - nearly 65 percent - of the volume on watchlists. By balance, $47.7 billion of 2006 loans and $55.3 billion of 2007 loans are on the watchlists.



During those years, lenders regularly underwrote mortgages based on collateral properties' projected property cash flows, as opposed to actual cash flows. And those projected cash flows in many, and perhaps most cases, have failed to materialize.

The drop in cash flow resulted in debt service coverage ratio (the minimum ratio of cash available to the amount needed to pay interest and required principal paydowns.) What's interesting is that a large portion of the earlier commercial mortgages did not require principal amortization.

Source: Bloomberg


That means that in many cases there is barely enough cash to cover just the interest. For many of those loans, principal payment will come from the property liquidation. Needless to say all the new deals require a full or partial principal amortization - similar to a typical residential mortgage. But the new deal flow has collapsed, and there is little primary market to take out maturing debt. There is hope that TALF may help, but nothing of significance has been refinanced yet (see: So far no CMBS takers for TALF)

Deals outstanding by year of origination (Bloomberg):


In addition to the refinancing problem CMBS deals are facing, delinquencies in CMBS are now starting to creep up.

From Moody's:

Moody's thinks this will jump to 5-6%. Let's take a look at how that breaks down:




Multifamily delinquencies have been on the rise for some time now because apartment rentals are heavily linked directly to the more vulnerable consumer. More recently hotel and mall (retail) properties are showing signs of stress.

Not that ratings mean a whole lot, but it's interesting to see how the rating agencies are trying to catch up to "correct" the errors of the credit heyday by doing rapid-fire downgrades. Here is a chart from Bloomberg that shows upgrades and downgrades of outstanding CMBS:



And who were the originators that underwrote the deals with the highest delinquency rates? Well here they are:

From Bloomberg, sorted by the number of delinquencies (the columns indicate how late the borrowers are on their payments) :


The spreads on senior CMBS paper, though off their peak, continue to stay extremely wide - effectively at distressed levels.

CMBS spread to treasuries:


So far there is no end in sight for the stress in this market. On top of the worries over the refinancing cliff, delinquencies are creeping up. All eyes are now on TALF as the Fed is getting ready to transfer some of the risk to the taxpayer's balance sheet. From Reuters:

Most commercial mortgage-backed securities eligible under published guidelines for the Term Asset-Backed Securities Loan Facility will also meet other Federal Reserve criteria, the Fed told investors on Friday, according one investor and a dealer.

So far no CMBS takers for TALF

A quick look at the breakdown of TALF financed asset classes is shown below:



As expected it is dominated by credit cards (54%) and autos (29%). CMBS based loans are strangely missing.

From the Fed:


Is it too early? Premium Finance ABS program was announced around the same time as the CMBS program and some Premium Finance bonds have already been financed with TALF. Premium Finance loans are used to distribute corporate insurance (such as hazard insurance) premium payments over a period of time rather than in one shot.

Here are the haircuts (the amount of equity an investor has to put up to finance CMBS securities) from the Fed:

CMBS Average Life (years) 0-5: 15%

For CMBS with average lives beyond five years, collateral haircuts will increase by one percentage point for each additional year of average life beyond five years.

The financing rate is LIBOR Swap Rate + 100bp. 15% down, the government funds the rest. You would think people would be lining up to do this. What gives?

Is it possible that even with all the nice leverage the Fed is providing, there are not many takers? This is not a typical 3-year auto deal that is clean and predictable. CMBS has some serious refinancing risk (chee chart of maturities below) and TALF may not be there when the time comes to roll. Leverage doesn't help when you don't believe in the asset.

CMBS Maturities (source: DB)


Reuters is quoting Citi saying the delay is due to complexity.

"Nobody was expecting any deals to be ready in June," said Darrell Wheeler, head of securitized asset strategy at Citigroup Global Market. He said they would come in July at the earliest, and more likely August or September due to the complexity of the origination and structuring process compared with other assets eligible for a similar Fed program.

We'll track the situation closely.