Tuesday, March 2, 2010

Bottoms Up?

Numerous sources have been hinting at a bottom in CMBS, including Barclays who said,

From a macro perspective, an uptick is a clear positive, as it suggests that the gap between buyer and seller preferences is narrowing and could signal that some believe a bottom in prices is approaching.

Housingwire noted that the CPPI is now down 44% on average, and 58% down for distressed properties - back to 2001/2002 levels. They also noted that the insurers bid will come back now that they can rate their own bonds - maybe for new issue, but not so much on legacy assets would be my guess.

They also note the coming risk of partial IO bonds, and this is a very real threat. Up until just last month, we were averaging about $2.5 billion in partial IO rolls each month, but that just spiked above $3 billion in January, and touches $4 billion by July. After a loan rolls from partial IO to amortizing, the average increase in debt service costs is around 20%, but lower coupon loans can get substantially above that, and amortization terms are all over the place. Although CMBS loans were ideally on stabilized properties, the worst offenders of proforma underwriting were loans structured as partial IOs - the lender would underwrite rents in year 5 to the necessary level, and to make it cashflow, would just not require amortization payments until month 61 (as an example).

As a more specific example, take a look at the largest loan to roll to amortizing payments this year, Grand Plaza, $86.5mm, in CD 2007-CD4. That property generated NOI of $6.4mm, and had debt service of $5.1mm last year - the new annual debt service will be approximately $1mm more at $6.1mm. The property cashflows at that level, but the debt service increased by 21.5%, and the property is already underwater at anything above 6% cap rates.

In all fairness, even last year, we had about $30 billion in partial IOs roll, which is about the same for this year, 2011, and 2012.

The biggest near-term concern is the expiration of TALF this month, but Citi made a very good point last week that repo lending has made its way back for most TALF-eligible bonds, and is competitive with TALF financing. They make a linear argument, but fail to explore why anyone would risk TALF if they could get a better deal in the repo market. TALF is clunky, and does not curry favor with either party like a nice repo line can.

Several folks have pointed to the 100 or so bps of tightening over the last 3 months, but in the grand scheme of things, the market has been pretty flat since last fall.

So, a bottom? maybe, but I think it's too early. We still have a lot of pain to work out in the pipeline, LNR still needs to file for bankruptcy, and we're only just starting to see a deluge of defaulted CMBS properties getting sold at viable prices. I don't think there is much to gain by holding a position through March just for the carry, but I also don't think we should all just sell all MBS like PIMCO has done.


RJ said...

fyi link to the last image is broken kthxbye

Dark Space said...

That's too bad - it was the bottom ;(