Wednesday, October 7, 2009

Partial IOs - Holy Collateral Batman

Planting a timebomb in a local library is a felony. -Batman

In the CMBS universe, you historically stuck your transitional loans (going under a rehab, or buyout financing, non-stabilized properties) into a Floater, and your stabilized loans went into the larger, and more common, Conduit/Fusion universe. However, in later vintage deals we saw a lot of Partial IO loans - initially these were commonly used in a situation such as a New York Class A office building with 30% of it's tenant base on long-term leases at $48-60 psf expiring within 5 years of origination.

Let's make that our hypothetical example (based on a real loan). When the loan was underwritten in 2007 Class A Office rents in Midtown peaked around $120 psf. The loan was underwritten under the assumption that the 100% occupied trophy asset would re-lease the rolling tenants at $90 psf (to be conservative ;)) with a 1.2x DSCR. However, the debt service wouldn't get covered unless they did an IO loan, so the borrower and the lender agreed to do a Partial IO, where the borrower would pay just the IO portion for the first 5 years, and then roll it into an Amortizing loan starting at month 61, with a total amortization period of 360 months. The interest rate is 6.14%. They also have a mezz loan which is barely covering - the 1.2x DSCR is just for the senior piece.

Turns out 2009 Class A office rents are closer to $65 today, and have room to come down, so the stabilized levels never get met. It's covering the IO-only at 1.2x. At month 61, they roll to Amortization and the debt service goes up (roughly 18.9%), and the DSCR drops to 1.009x on the senior, and their losing money once you factor in the Mezzanine loan.

Take the same hypothetical loan at a 5% interest rate (a 28.8% increase in debt service, your denominator), and your post-IO DSCR is 0.93x on the senior. Take it up to a 7% interest rate (a 14% increase in debt service), and life still is not good with a 1.05x DSCR on the senior.

1 comment:

Rational Realist said...

I analyzed a bunch of securitized tenant in common programs. All used partial IO financing. Most had DSC of 1.5 times or more with reserves for leasing costs, but like you say all were based on pro forma lease rates. The amort. period is always were things got dicey. With most being five years and most deals done n '05 through '07, 2010 to 2012 should be interesting. The LTVs were typically 75% or less (many less), which may offer some time, but the TIC holders are out their equity.