Thursday, September 17, 2009

Sunny Day Real Estate - ProForma Underwriting

Sunny Day Real Estate was the original emo band of the '90s - The cover art is of the "Bronze Angel" in Vancouver, which I've always suspected was actually a Valkyrie, rather than an Angel, which scoop up the deserving and bravest heroes off the battlefield.

Proforma loans were less pervasive than the media would have you believe, but they are going to cause significant pain in the CMBS universe. There were about a dozen deals where more than a quarter of the loans were underwritten with some form of proforma underwriting. This came in two primary flavors:

  • Cash flow proformas - Property lease rolls indicated that new lease rates would be significantly higher. This was common in NYC Office where old $30 psf leases rolling over the next few years were underwritten using $100+ psf leases - most of these are more likely to be in the $60-70 psf area assuming things don't get much worse than they already are. Also common in NYC Multifamily where the landlords devised the strategy of kicking out rent control tenants and replacing them with market payers. The loans typically required a significant debt service reserve account to be set up in advance to cover the planned shortfalls in mortgage debt service - a lot of these accounts will dry up in the next 12 months (a few have already: Meyberry, Riverton, etc.; but bigger ones are coming: PCV/ST, 666 5th Ave, etc.)
  • LTV proformas - These were typical of loans that were, say, partially completed and leased out with a portion of the collateral under construction. No names jump to mind, but you can easily envision the Phase I shopping center that is leased with a Phase II under construction that is underwritten to a higher LTV. You can also picture the office tower with unsold condos and penthouses as collateral.
Trepp has identified about $38 billion of proforma loans (less than 5% of the market), but that doesn't seem to quite capture the issue. They looked at all conduit deals issued since 2005, and also included a few older deals and some non-conduit deals. The methodology was not disclosed to my knowledge.

Using data from Trepp and Intex, I backed into a number for cash flow proformas that is closer to 8% of the loans issued during 2006 & 2007. The dozen deals that Trepp identified as having more than a quarter of their collateral being proforma matched up with my results. It deserves some more attention, and I'll come back to the subject and post methodology and results at some point in the near future.

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