A Comprehensive Review of CMBS

Bank of America put out a primer on CMBS earlier this week that is really the best I've seen.

I'm trying out filefactory, so click here, and go to the bottom and click the Download with FileFactory Basic link...

I'm on the look out for some other file-sharing sites for this type of thing - let me know if you have an opinion on a good one.

Rumors confirmed

Last week we started hearing that Perot's investment firm was unwinding and flooding the CMBS market, further widening the market. it's not clear how much they have left to sell, but that surely contributed to the perfect storm we saw...

hat tip, carney @ clusterstock.com

DBSI Bankruptcy - next CMBS headline

You already know about the DBSI bankruptcy earlier this month if you play in the CRE space, but the connection to CMBS hasn't really been broad market news despite a Moody's downgrade on the MLMT 2008-C1 deal (8% exposure to DBSI).

Bridger is advising, defaults & liquidations are likely, and losses are expected given the market. I haven't done the credit work necessary to make a judgement on how bad losses may be, though the properties may all be performing well and things may not be too bad - I have no idea yet. The Bankruptcy has its own blog, how hip is that - http://blog.dbsi.com/

Going Stag, The Hartford Way

Insurance companies typically do not have to mark-to-market in the same sense as, say, a bank's held-for-sale investments, but rather they reflect reasonable impairment expectations. Mark-to-market can wreck their balance sheet, but their CMBS portfolios typically are relatively unlevered long-term investments to match expected insured payouts.

Expertise in CRE is not hard to find at most Insurance companies - they account for a large chunk of the commercial mortgage lending market themselves and have seasoned real estate staffs (mostly).

Typical CMBS investment - AAA 30% subordinated CMBS. Why? Its 10-years long and bullet proof. They want something that will be there in 10 years (or longer) so they can use it to pay off insured payouts.

Fixed Income Spelling basics

Subprime, not sub-prime, which is an inferior cut of beef.

CMBS, not C.M.B.S, in fact, just don't put periods after any acronym and play it safe.

CMBS stands for Commercial Mortgage Backed Securities, not Collateralized MBS. Even if you're from the UK, you're still wrong.

CRE stands for Commercial Real Estate, not Consumer Real Estate - okay, maybe this is debatable.

Its Tranche, not Traunche - although I am in complete agreement that old texts show a 'u', we don't do that anymore, please stop.

Its okay to say Treasurys or Treasuries

Everyone understands that everyone else has not been living and breathing bonds the last couple of decades, but if you don't take the effort to do just basic research on a sector (which would reveal correct spellings and such), then don't expect anyone to give your article more than a passing glance.

REITWrecks wins the best title of the day award - TARP Torpor Torpedoes REITs

http://www.reitwrecks.com/2008/11/tarp-torpor-torpedoes-reits.html#links

REITWrecks is one of my favorite blogs, although it wouldn't hurt my opinion of them one bit if they published more frequently.

A couple of comments though on this posting. The quote from Green Street Advisors' Mike Kirby only shows that Mr. Kirby has not looked at the data. There is not really that many CMBS loans maturing in 2010, even considering the hobbled loan market - its one of the more docile years, although 2011 and 2012 start to get hairy. Less than 8% of the outstanding CMBS loans mature in 2009 and 2010, combined. The lending market is not shut down, but if it remains hobbling along until 2010, some loans will have issues and will likely be extended. Most of the CMBS loans maturing in 2010 were originated in 2000, only some from 2005, none from 2006 or 2007 (at least not from the Conduit market, maybe a few floaters).

Everyone else is right on. Prices on AAAs dropped even lower since Pendegrast and Wheeler's comments. You really would have to see every commercial loan default, and have horrific recoveries, to justify these levels. Even then, it frankly takes a year or two to repo, market, and sell a foreclosed property - some of the current pay and front pay bonds, yielding 13+% more than Treasuries, get paid off even if you assume 100% Defaults and 99% losses!

US Bailing out Citi?!?!?

From the WSJ, although GasPak was out with hints of it earlier today...

This may not be all bad, and it all depends on what their 'mortgage-related assets' really are, but the bad bank-good bank idea that was floating around is likely not good for stakeholders in the long-run in this case. Allowing Citi to take the first 13 - 14% loss on assets and the government coming afterwards, might be a good deal for everyone if the government is receiving a fair insurance premium for their backstop and if Citi's MBS exposure is being hurt more by liquidity than credit.

Cheap, Cheap, Cheap

This WSJ article got a lot of things right, and deserves praise given the deluge of poorly written articles this week.

Triple-A commercial mortgage-backed securities are trading at roughly 70 cents on the dollar, meaning they would produce a 20% return if held to term.

That's

Back then the cumulative default rate on loans made in 1986 reached 36%.

This number sounds fishy, but not having the data handy let's concede its true. That would mean the average default on any given year for the 1986 was around 3.6%, some were cured, some were foreclosed on and took losses.

Moody's Sees Pressure on CMBS Ratings - with help of seeing eye dog

Moody's is a farce ...

Moody's Investors Service expects U.S. commercial mortgage-backed securities' ratings to face downward pressure in coming months as falling demand cuts rents and boosts vacancies in the U.S. commercial real estate market.

Its just despicable that rating agencies have done such a poor job - how are they in business?

Peter Cooper Village Stuyvesant Town

This is going to be a long post. I wanted to walk through the PCV/ST loan and some possible outcomes

Peter Cooper Village/Stuyvesant Town (PCV/ST) is an 11,227 unit multifamily complex built decades ago by MetLife for the working class. Blackrock and Tishman-Speyer purchased it in 2006 for $5.4 billion, larger than any other real estate transaction in the US – ever. The senior note serves as collateral in four different CMBS deals, with a total of close to 100 bonds, and is part of two CMBX indices, CMBX.4 and CMBX.5. It is a big deal.

The intended strategy was to kick out the rent-control tenants (paying under $2k in NYC, many are paying around $1,200 at PCV/ST) and move in market-paying tenants (lowest available market rent apartment is a 1-bedroom in the bargain basement for about $3,000). With the high number of rent-control tenants, the apartment complexes don’t bring in enough income to even pay their first mortgage (much less the additional debt), so the underwriters required that they set aside a large reserve account ($400 million) to help pay the debt service while they were in the process of kicking out the despicable rent-control tenants living off the back of the rest of us executing and monetizing their business plan. Perhaps a little unpalatable, but a relatively easy to follow strategy.

As one might expect, assuming you haven’t been on an island (did anyone see the article on the last page of Bloomberg magazine last month on Necker Island – my daughter walked in while I reading it and insists that we must go. No matter that a single night cost more than we’ve set aside for her entire college expenses. I need to add a donate button to this website asap!), the strategy is not going exactly as planned given the anticipated job losses in NYC and, frankly, the difficulty of kicking out rent control tenants in the first place. This is not the only JV that created a plan to flip rent-controlled units to market-paying tenants in NYC and financed via the CMBS market. Further, it turns out that the strategy really is pretty unpalatable despite successfully kicking out many who were gaming the system. Not to point fingers, but Charles Rangel (as in Rep. Charles Rangel, HEAD of the House Ways and Means committee) had FOUR rent-control units at Lenox Terrace; one was being used as campaign office before the landlord took that one back. They also kicked out Mick Jagger’s ex-wife because she isn’t even a legal US resident, and won a lawsuit in October 2008 to that effect – other, related, lawsuits remain undecided at the time of this writing. I'd be very concerned if not a US citizen living on rent control - the PE guys are going to exploit this strategy...

NYC mayor Bloomberg, and others, helped get new laws in place in March 2008 that allowed tenants to fight back when landlords wrongly tried to evict them. Part of the strategy, you see, is to sue every tenant possible over the tiniest of things with the hopes that they’ll find it too expensive and a waste of time, and just move somewhere else. There was not a lot of recourse for the tenants, so the landlord could do this over and over to the same tenant. Not anymore – three times constitutes harassment under the new law, and an addendum to the law (currently being considered) may allow for the tenant to sue for damages three times their legal costs for defending themselves. Needless to say, there are roadblocks in place now, that were not taken into consideration when these loans were originated.

PCV/ST is not going as planned, but it’s also not really as bad as some would have you believe. Moody’s states that their debt service reserve (put in place to ensure they could pay their mortgage while they deregulated units) will run out sometime in 2009. Although they have kicked out number of tenants in rent-controlled units (about 1,000 so far), they’ve mostly been one bedroom units, which just aren’t as profitable to deregulate. They’ve also spent a ton of money improving the “Oval” area, and improved landscaping throughout. They’ve unsuccessfully taken nearly 400 tenants to court since the loan was originated (that is a lot of pissed off tenants).

Moody’s calculators must work differently than any that I’ve tried, which is likely related to their poor job at rating deals. The last few draws on the reserve account have been around $10 – 11 million, and the balance was around $165 million last month – give or take a million or two. So, if they are unable to deregulate any more units at all, and keep occupancy roughly in line, they have 15 months of reserves left (right? 165 divided by 11 equals 15). Some reasonable inputs can get you out to 24+ months with a straight face. It’s not running out of money in the very near future.

Utilities, traditionally paid by the landlord, have cost around $10 mm a year (a little more this year). They started installing meters in October 2008 and are going to bill the tenants. All of the fancy landscaping and changes to the Oval – that is what you call a Major Capital Improvement, or an MCI, and you bill your tenants for it. The Oval will have some new services next year and memberships will be available for $250 per year and $25 a month. To twist someone else’s words about the landlords – if anyone can squeeze blood out of this turnip, it’s the heartless MDs young professionals leading the effort.

Now, I’m not saying this is going to work out, I’m just saying it’s better off than the Savoy or Riverton, or any number of similar, albeit smaller, deregulation projects. And, the real problems are quite a ways off. Further, how do you short it? Hedging is more expensive than ever before, not to mention that this is only a small part of the CMBX indices. Heck, let’s say it defaults in 16 months, and let’s assume that it takes a couple of years until the loss actually takes place (it’s extremely reasonable to expect a 1.5 to 2 year disposition period before the asset is resold) – You’re in 2011 or later before the CMBS deals are at risk of a loss. One of the rating agencies have pegged the current appraisal value at a 10% discount to the origination level – the senior mortgage LTV still implies a $0 loss.

However, I think it will make for some great headlines. There are a number of blogs that are almost entirely, or have PCV/ST sections, devoted to this one property, and its frequently used in 'exposes' in such fine publications as WSJ, NY Observer, Barron's, Crain's, and others. Its also in NYC, where all the financial researchers and journalists live (its close to home, they ARE aware of it), and it has a massive $4.4 billion mortgage (multiple senior and junior portions).

What is the play here? For CMBS investors, pray for the headline risk, pick up the AAA bonds off the four deals this loan is on. WBCMT 2007-C31 is a fine play, but the upside is rather limited to be honest. WBCMT 2007-C30 is a good one - no real downside, but there is some upside if this particular loan defaults (you get paid back quicker... at par, with AAAs trading at $0.50 to $0.60 cents on the dollar - that could be vewy nice!).

I actually have a better play that I'm not disclosing at this time, but I'm willing to share it for a small advisory fee.

Westin Portfolio - Everythings okay, nothing to see here, keep moving people

Two big loans missed part of their October mortgage payments, resulting in a 20% delinquency rate on a rather small CMBS deal that was the worst of 2008. It wasn't a surprise that these particular loans failed, but rather that it happened so quickly (even that was just a little surprising). The other big surprise is how badly it affected the market - the head of CMBS research from Citi was on CNBC last week for pete's sake.

Commercial Mortgage Alert reported on Friday that the owner's of the two Westin hotels were attempting to raise capital and cure the default, but they also have mezz debt on the properties and the senior mezz holders (Ashford Capital) have stated they will cure it within 60 days and take over the properties if the owner is unsuccessful. So the mechanisms in place are working, and the loan will likely cure for the time being. The Arizona Westin still seems like a weak asset to me, but maybe it will right itself.

Biggest INVENTORY LIQUIDATION, evah!

Steve and Barry's was destined to be an Epic Fail. Although many prime retailers pay little to no rent and get concessions from Mall owner's in exchange for the foot traffic that they hope the retailer will generate, S&B took this to a new level.


They're strategy, and the bulk of their revenue, mind you, was to seek out large dark space (no relation to the author) at weaker locations, receive cash payments for gracing the mall with their presence, use said cash to pay for their big marketing budget, and pray that will result in real customers that will generate enough revenue to hide their poor business strategy.

It flopped, they went bankrupt, were bought by a firm out of bankruptcy just 3 months ago, and have now flopped again. Its not clear if the firm that bough them, Bay Harbour Mgmt., was smart and sucked some value out of the retailer's last few breaths, or if they grossly misjudged the acquisition...

Michael Lewis - The End

Really a fine writer, even when it comes to boring bond desks. I think Liar's Poker is required reading for new AnaLysts, and now that the rest of the world has an opinion on structured products, they should at least give the book a try.

His thoughts on The End at Portfolio.com

CMBS spreads continue to gap wider

Headline risk rules supreme.

Other's Views

CMBS Melting - John Jansen

Freefalling - seeking alpha

Insurers are slaughtered - Fortune

Some folks are just joining the party, please excuse their naivete

Delinquent loans actually moved the rest of the market...

The story on the two CMBS loans, while not trivial, actually helped push the rest of the market down. I don't think its a huge surprise two loans are having issues, although it is a bit soon, and it really is a big deal that 20% of an 8-month old deal is delinquent and likely to default.

Reading through the description of the Promenade in the prospectus (not the hard numbers, the glossy qualitative comments that are supposed to sell you on the loan) you can't help but wonder... It's a retail life center development, with a residential component, ... and a class A office components, a senior housing component, and well, what else can we throw in there, how about some resort stuff, a golf course, and, why not - a nature preserve. Instead of having a strategy, let's just pick every property type and throw it in the desert, and see if it'll work. While we're at it, let's use this strategy to build in 10 different locations, and literally spread them out from the East to West coasts and everywhere in between. We have a test-case.

The other loan is on two Westin hotels. Obviously hotels have got to be hurting in the current environment - I'm quite literally staying at a hostel in a couple of weeks (Yes, that is not a misprint, it is a HOSTEL, with an "S", and no, I didn't pick it and I'm arguably not really young by most people's measuring stick, but that's where I'll be sleeping nonetheless). One of the Westins in question is on Hilton Head and has beautiful ocean views - despite any short-term cashflow issues, it's a joy to stay there. The second collateral property is in the desert (Arizona) and derives at least half its revenue from corporate travel (I assume these are mostly conferences, given the location) - when the deal was issued, Moody's noted they didn't have enough meeting space, and the sponsors started building out more. Talk about a bad plan with bad timing.

Anyway - the whole market moved wider on the news. I can't find any other reason. Everyone's talking about it. Nothing changed politically.

*I'm pretty sure that's a knife in JP's hand in the picture, and that kind of freaks me out, but not as much as it should whoever just drug his fine name through the muck.

Is the 2008 Vintage too young to be a delinquent? -- JPMCC 2008-C2 says no

The #1 and #3 loans in JPMCC 2008-C2, together accounting for nearly 20% of the deal, are both delinquent 30+ days as of this past Friday.

What do you do if 20% of your deal defaults inside the first 12 months? Do you call it Subprime CMBS?

Still Recovering from our government's latest blow to the financial markets...

I'm really at a loss for words - the government seems intent on making things worse. By removing the assumed imminent back-bid for structured products, Paulson sent spreads spiraling upwards.

Calculated Risk summed it up well.

MTV still has its Crib

Viacom renewed its lease at 1515 Broadway, aka 1 Astor, where they house MTV, BET, and Paramount Pictures.

Maturities, Wave of Mutiliation

I'm not sure if its all the journalists misquoting someone, or if the someone they keep quoting in places like here, and here.

Distressed sales of commercial real estate may rise next year as about $36 billion in securitized loans written in 2006 and 2007 come due

I don't know where they're looking, but including Conduit and Floaters, and every esoteric sector out there, we have around $25 billion due next year. Even if you forget to account for extensions, it's hard to get to their number --- and most of the loans maturing were originated last century (none, or close to it, were originated in '06 or '07).

''The special servicers are not making it easy to assume these debts,'' he said. ``They're taking the opportunity to take another bite of the apple.''

Special servicers are not there to make it easy - the reason you are talking to the special servicer in the first place is because you've failed to meet your end of the agreement. The special is supposed to do what is best for the investors, and sometimes that means they extend a maturity date, sometimes they foreclose on you and sell their property for as much as they can get - you know that is what is going to happen when you get into the loan (you can't blame it on ignorance, this isn't subprime resi land anymore).

Dozens of loans maturing in NYC over the next few years...

Don't get me wrong, but the headline is the equivalent of telling us that dozens of pigeons will relocated to Central Park over the next few years - it's just not attention grabbing enough.

But that didn't stop the writer of this report, so he added some misinformation to juice it up.

Such loans are typically held for five years

Which ones? CMBS? No, they're typically 10 year loans. There are some 5 and 7 year loans, and some shorter in the Floating-rate sector.

The borrowers will likely have to pay higher interest rates as well as contribute equity

Higher interest rates than when? 10-years ago? The spreads might be higher, but the true rates are probably lower or at least comparable (although they'll need to go outside the CMBS market to get funding right now). Additional equity? After 10-years of appreciation, on loans that do not have junior and mezz debt, will not need additional equity.

GGP publicly warns of default

Mall Owner Is Warning of Default

General Growth has $900 million in debt coming due Nov. 28 on two luxury malls on the Las Vegas strip. It has another $58 million in bonds due on Dec. 1. The company is attempting to meet those obligations by selling those two malls as well as another on the Las Vegas Strip. It also is negotiating with its lenders to gain an extension on its deadline to pay those debts.

Since the CMBS financing fell through, this has become more and more likely. GGP has loans in a lot of CMBS deals, most are longer-term loans, but some shorter term loans are due this year. They also have a bridge loan, which was used to pay down the CMBS loan on Fashion Show Mall last year, which comes due any day now.

Most of the assets are strong assets and cover their debt well. Its highly likely that CMBS servicers (and others) will extend the maturities on loans that are performing well. Any properties that do get foreclosed on may see longer recovery periods than usual (just given the lack of credit available), but losses will be minimal, or 0%, on the senior CMBS mortgages.

Simon is next in line. They have a fair amount of debt due over the next 18 months, but keep in mind it only seems like a fair amount due to current market conditions - in reality we're talking about $1 or $2 billion. In fact, if you lump all the REITs together, and look at senior mortgage debt maturing each year, it's less than $20 billion in '09, less than $25 billion in '10, and then hovers around $25 billion per year for the next several years - its not that much in the grand scheme of things, but could be devastating if there is no money to refi with.

Circuit City Bankruptcy

Nothing new here, but also not much of a chance for exposure. You can count the CMBS deals on your fingers and toes, and the only ones with significant exposure can be counted with just fingers. They tend to be in strip centers or in standalone stores (for some reason these seem to be horrible locations), which do not have any significant REIT exposure (DDR has a little exposure, but its not related to today's 25% decline in their stock).

I'm not sure exactly where they locked in their decision to fail, but it could have been in 2003 when they decided their knowledgeable sales staff were making way too much with the silly commission-based pay, so they fired them all and replaced them with your typical high-school grad (or not) working for an hourly wage, just long enough to find a better job, with no experience. The handful of these employees, bless their hearts, that survived enough to get some pay raises, were subsequently let go in March 2007 - again because they were paid too much. Purportedly, the same employees were asked to rejoin the firm just two months later after sales plummeted (whoa, the sales people were SELLING things? That's just crazy logic).

Management turned down multiple buyout offers and cobranding strategies, sold and allowed profitable lines of business to leave the firm, fired all the good employees, maintained horrible locations (even after the currently announced closures), and now they're in Chapter 11?!

Of course, this filing does let them reject leases in bankruptcy court, and is a negative for the CMBS deals where they reside, and a horrible negative for any employees that are left (take your severance and move on ASAP).

Isn't it about time for another line - Verizon Center 1095 AoA

Another hat-tip to CalculatedRisk, Verizon Center was in the NYTimes yesterday regarding tenancy issues, namely the largest tenants to sign leases are all backing out. If you stay long enough, you realize this is the Verizon Center (1095 AoA) that EOP sold to Blackstone at the exact pinnacle of the market. It is the largest loan in the GSMS 07-EOP deal.

Image Above: Verizon Center on the left, BOAT on the right


Honestly, by the end of the article I left a little confused by who occupied the building, who had dark space, if there were sublessors, etc. Obviously, though, the new owners were hoping for $130 psf and up for the primo space, and $100 and up for the rest... and they're lucky to get more than $95 for any of it now.

A Hit on the Godfather

I read about it half way through my first coffee this morning and did not make the connection
until I saw CalculatedRisk's comment this evening - Franklin Bank is Lewis Ranieri's bank, and it got SHUT DOWN this weekend. His firm AFR (own bank branches and financial buildings and lease back to tenants) has also had some issues in recent years.


As most anyone reading this obscure blog will already know, this guy is the original greasy-cheeseburger-eating-BSD in Michael Lewis' Liar's Poker.

There is AFR exposure in CMBS deals, one deal was solely AFR collateral, and there are a few smaller portfolios. Not sure of Franklin Bank exposure, but I don't believe it had a huge footprint. The Bloomberg article indicates its downfall was loans to developers both development and construction, and raw land loans.

All is Lost...

The CRE world has some pain coming, and no one denies that, but The Great Commercial Real Estate Crash: Mark Your Calendars in this week's WSJ misses the point.

Commercial real-estate securities have been Wall Street’s last claim to dignity. You might remember that Lehman Brothers Holdings in the final days pinned its hopes for survival on the values of its commercial real-estate portfolio.

Last claim to dignity? I must be on a different train - CRE has been the favorite whipping boy for at least the last 7 months. REIT equity prices are more than 40% off their highs, double digit unlevered returns are possible in AAA CMBS, and the AAA CMBX indices are implying the underlyings will experience losses 4 and 5 times history?

pinned its hopes for suvival on the values of its CRE portfolio? The train crash that I witnessed has Lehman moving some of the worst CRE assets out there into a separate entity - it was dumping them, not pinning its hopes for survival on them.

Commercial real-estate loans, including commercial mortgage-backed securities and collateralized debt obligations, total $3.7 trillion. It is only a slow burn right now: Many of those CMBS and CDOs mature in 2010 and 2011

The Fed reports outstanding CRE loans closer to $3 trillion, and a little less than 1/3rd of that is CMBS. The Journal might be double counting CDOs, but its not clear. I'm just roughing the numbers based on others' research, but the refi wave really starts in late 2011 and 2012 - less than 8% of the outstanding CMBS mature in 2009 and 2010 combined, and 2011 & 2012 have less than 9% of the outstanding each; most of those are 10-year loans maturing out of deals underwritten at the turn of the century. Late 2011, and 2012 are a little more problematic because the handful of 5-year loans from '06 and '07 deals start to mature.

Who stands to hurt the most? The list starts with the biggest holders of the loans, which include insurance companies, hedge funds and banks, specifically regional banks...
...investment banks took many of the highest-quality loans, leaving regional banks holding those commercial loans without stable income streams

Assuming, incorrectly, the pain will be felt most in CMBS - insurance companies have deep CRE experience. Before CMBS, they were the primary lenders for the highest quality sponsors for stabilized properties. CMBS stole market share, and insurance companies bought CMBS, but for the most part they picked the highest quality CMBS out there. Its easy enough to find Insurance Companies that failed to invest wisely, but thats for another post.

Regional banks are not big investors in CMBS. Regional Banks are the primary originator of land and construction & development loans (C&D) - the riskiest, shortest term, most likely to blow up loans out there. They didn't do this because the IBs only left these scraps on the table - this has always been their bread and butter because it has the highest risk yield.