The Gloves are Off (Seagram Building Pt. 2)

Reuters drops some nuggets of gold in this article but for the sake of brevity, and my 9am deadline, I'm going to paste the relevant pieces.  This is in regards to last week's post on CGCMT 2013-375P.

The Pricing

1. While this type of rating agency sniping has been going on over the past two years...it has never been timed in this way, according to industry participants.
2. "The underwriters clearly emptied the old bag of tricks on this one, as far as crisis-era underwriting goes, and the agencies [fell for] them," said the head of CMBS investing at one of the biggest asset managers in the country.
1.  Those tricks included re-measuring the building, lowering management fees in order to minimize projected expenses, and creating an 'optimizing' structure that pushes as much away from the mezzanine debt into the securitization at the Triple B minus level.
3. ...the Triple A portion of the US$572.9m transaction was increased at pricing on Thursday from US$75m to US$209m. Spreads on the most subordinate pieces widened considerably, however. The deal was originally US$439.75m. 

The Structure

1. The underwriters securitized the entirety of the so-called subordinate, or junior, portion of a US$782.75m commercial mortgage on the Seagram building.
1. However, they only securitized part of the senior portion, known as the A loan, leaving the flexibility to increase the Triple A piece in the bond transaction.  
2. he remaining unsecuritized portion of the A loan will be put into an upcoming multi-borrower CMBS conduit.

But let's get real people, this isn't the first pro-forma deal within the CMBS 3.0 space and it's not like Kroll and Moody's took the underwriter's assumptions at face value:

The Assumptions

1. ...they generally thought that the issuer's initial projected numbers regarding net operating income, occupancy, expenses, structure, and other metrics on the top-notch building were way too aggressive.
1. Therefore, each agency assumed a steep haircut on the building's net cashflow and valuation in order to arrive at its Triple A enhancement levels.
1. Kroll assumed 17.9% less than the issuer's net cashflow and 46.7% below the appraiser's valuation...
2.   Moody's undercut by 10.7% the underwritten cashflow.

The Other Elephants in the Room

1. In January, Fitch rated a CMBS titled GSMS 2013-KYO, linked to six hotels in Honolulu, which was said to have used pro forma underwriting; 
1. In response, the head of CMBS at Fitch, Huxley Somerville, said that Fitch used a highly stressed cashflow assumption on the deal backed by the Kyo-Ya hotel portfolio
2. The underwriter, Goldman Sachs, used pro forma assumptions to calculate so-called Revenue Per Available Room (RevPAR), presenting a projected cashflow of US$174.4m. 
2. ..last November Fitch gave Triple A grades to a deal linked to an office building, 1290 Ave of the Americas, with pro forma projections.
1.  Similarly, on the deal backed by a loan on 1290 Ave. of the Americas in Manhattan, Somerville said there was a US$10m leasing reserve to cover future leasing costs
2. the underwriter's cashflow was US$94.4m, while Fitch assumed US$89.9m.

  I'm still on the fence on this one.  If these kind of deals markedly increase over the next 6 months and CMBS teams at the dealers start making frequent weeknight appearances at Milk and Honey;
then I'll start to get worried. 


~Jingle Male
 

Nerd Fight!

Fitch does not seem to agree with Kroll's rating of a $782.75M, interest-only mortgage that was stuffed into the recent CGCMT 2013-375P deal.  For the uninitiated, Fitch seems to believe that the underwriting assumptions used to finance RFR Realty's acquisition of the Seagram Building is a bit aspirational, to say the least.

Basically:

"--2010: $53,560,729 (average occupancy of 96.9%);
--2011: $56,745,150 (average occupancy of 96.6%);
--2012: $54,078,388 (average occupancy of 94.4%).

This compares to the issuer's NOI of approximately $74 million and average occupancy assumption of 96.7%."

Citi and Deutsche  underwrote this one with about $20M in pro-forma income.  That is, the banks assumed that the property's earnings would increase ~37% via the following:

"--$10.2 million from the mark to market of rents assuming $135 psf for floors 2-12, $145 psf for floors 13-38 and $125 psf for the retail space;
--$7.8 million from the lease up of vacant space from 90.2% to 96.7%; and
--$2.2 million from a recent re-measurement of the building increasing the total sf to 858,000 sf."

I'm in the middle on this one.  On one hand I'd like to believe that Fitch has a point and is acting prudently but on the other hand, it seems as if they're still trying to make amends for missing some of the market tops that occurred in 2006 and 2007.  Not sure if Fitch is being proactive or reactive.

And then there was this (emphasis added):
Fitch provided preliminary feedback of $510 million at investment grade and was not asked to rate the transaction. 

But despite any butt-hurtness on the part of Fitch, I take a look at KBRA's assumptions and also the mezz jammed into this deal and it does make a Jingle Male wonder:

Right-click and select "View Image"

 So yes, let's see how this one plays out. 



~Jingle Male

Cumulative Defaults slightly lower than expectations (Fitch)

Fitch reports,

Cumulative default rate for fixed-rate CMBS increased 25 basis points to 13.2% as of the second quarter of 2012 (2Q'12). The steady increase in the default rate has so far in 2012 has been slightly better than Fitch's expectations.

Earlier this year, Fitch predicted that cumulative defaults would reach 14.5% by year end 2012. Newly defaulted loans for 2Q'12 total $2.1 billion (143 loans). Following the trend from first quarter 2012, office continues to lead new defaults at 44% with retail following at 34% by balance, respectively.

The total universe represents fixed-rate deals issued between 1993 and 2012, totaling $569 billion (excluding the Freddie Mac securitizations). Loans are considered defaulted if they have been reported 60 plus days delinquent at least once.

Bloomberg states that new issue CMBS LTVs exceed 100%

Of course if you actually make it to the 8th page of Ms. Mulholland's Bloomberg article...

Lenders use a different formula to calculate a property’s value relative to loan size than Moody’s, resulting in a lower leverage ratio. On a $1.35 billion offering from Morgan Stanley and Bank of America Corp. sold last week, the issuers estimated the average office loan in the pool to be equal to 65.5 percent of a building’s value, compared with Moody’s 109.7 percent, according to the rating company’s assessment of the transaction.

So Morgan Stanley and Bank of America are using appraisals, and Moody's is basically making up a number. It should really just say that at the very top of the article. Moody's takes two numbers to estimate their version of the LTV for a property, stabilized income (so not actual current income, which is what is commonly used in CMBS 2.0 appraisals, and even many CMBS 1.0 appraisals) and higher cap rates then the current or even near-term projected cap rates. While I'm not so naive to believe that appraisals are always accurate. However, it is equally naive (at best) and potentially dangerous for Moody's to imply that this is an accurate accounting of value. Last year, they had the nerve to actually state the following:

In contrast, Moody’s LTV highlighted the growing credit risk late in CMBS 1.0 and is much more consistent with the now evident performance patterns of recent vintages.

So, they would have you believe they saw the storm coming, but continued to rate the bonds exactly the same despite believing that the vast majority IG-rated CMBS they put their stamp on was underwater and would likely be downgraded?

I do believe that Moody's Stressed LTV is useful in analyzing loans in a deal, but it should clearly be labeled as such. In papers specifically about the measure, they label it Moody's Stressed LTV, and highlight that it may be useful in identifying potentially overlevered properties within the confines of a model. But they also seem comfortable with allowing a reporter to publish articles such as the Bloomberg article above and frequently will just call it Moody's LTV.

S&P to Revamp CMBS Ratings

WSJ reports that S&P is revamping it's CMBS rating system:

Since that event last July, no issuer has hired S&P to rate any of multiloan CMBS deals, which have typically been $1 billion in size. More than $12 billion in CMBS have been sold this year.

Payback hurts, doesn't it. We have not analyzed the proposed changes, but we have to assume that they are doing more than just calling all the new loans "crap", as an S&P analyst was quoted saying back in February 2011, just 4 months before the ratings firm was essentially blocked from all new issue deals.

My favorite quote is:

Harris Trifon, a CMBS strategist at Deutsche Bank, said that "at first glance, it seems the magnitude of the changes will disappoint most investors."

They fail to mention that he is a former S&P analyst. He's a nice guy, and he's probably right - heck, he probably knows more about S&P than just about anyone in a research group on the Street - but it just seems like WSJ would disclose that, right?

CSMC 2012-CIM1

Bloomberg had a TOP story on CMBS RMBS today (that's always so exciting!) talking about how Fitch thinks S&P is grossly inaccurate in giving Credit Suisse AAA ratings on bonds with just 8 percent subordination, noting that Fitch would never dream of assigning a AAA rating to any bond with less than a 9.75% subordination rate.

I don't know if those are standards worth arguing over or not, but at least they disagree on something.

Update: I incorrectly noted this was a CMBS deal on Friday, but Anonymous corrected me and it looks like it's a resi deal.

S&P frozen out of CMBS

Bloomberg TOP story:

Standard & Poor’s is frozen out of the commercial-mortgage bond market by the biggest underwriters after derailing a $1.5 billion sale by Goldman Sachs Group Inc. and Citigroup Inc. last July.
Since then, those banks along with JPMorgan Chase & Co., Deutsche Bank AG and Morgan Stanley have bypassed S&P’s credit ratings as they issued $11.3 billion of debt linked to skyscrapers, shopping malls and hotels, according to data compiled by Bloomberg.

My favorite snippet:

Ed Sweeney , a spokesman for S&P, said the New York-based company’s CMBS analysts weren’t available to discuss the situation. “We believe our ultimate success will be based on the value investors derive from the ratings and research,” he said in an e-mail.

Be on the lookout for Harold McGraw III (known to his friends as Harry 3-I) trying to unload his S&P position ...

Fitch officially changing their name to Farce

Does anyone really put any stock at all behind anything Fitch says? Is there really anything left to downgrade at this point?

The era of broad negative mortgage-backed securities ratings from Fitch Ratings is over. Sans a "few pockets of weakness," RMBS and CMBS downgrades will diminish significantly, the agency said this week.

Despite persistently high unemployment levels and projections of a slow economic recovery, Fitch expects downgrades to be more incremental in nature, seen by notches and not rating categories.

Fitch projects prime RMBS and most CMBS to be among the categories that demonstrate strong performance, even if economic trends deteriorate modestly.

"New transactions issued over the next 12 months across all of structured finance will be more conservatively structured and demonstrate superior performance compared to past vintages," says Kevin Duignan, group managing director and head of U.S. structured finance for Fitch.

B Students

The rating agencies have obviously fallen down on the job, and no one disputes that. However, the most troubling comment you hear over and over are ones like this:

"It's clear to me we can no longer rely solely on the ratings agencies," Sean Dilweg, Wisconsin's insurance commissioner, said following the hearing of the National Association of Insurance Commissioners on Thursday in Maryland.

Dilweg is talking from the perspective of a regulator, not an investor, but NO ONE should ever have been relying solely on a rating agency to measure risks without a more transparent process in place (so you could further rate the rating agency's process). If he were an investor, rather than a regulator, he would be immediately fired for such a comment.

Realpoint Approved by NAIC as a rating agency

Sorry no link to Bloomy article, but this should be another big win in the AA and up space. Insurers have to set aside significantly more money once the middle rating drops below AA.

Sept. 23 (Bloomberg) -- State insurance commissioners, seeking an alternative to rating firms Moody’s Investors Service and Standard & Poor’s, approved Realpoint LLC to evaluate commercial mortgage-backed securities in companies’ portfolios.

The ruling by the National Association of Insurance Commissioners means state regulators can rely on Realpoint in determining how much capital must be held by insurers, Scott Holeman, spokesman for the group, said today. Realpoint provides analysis to bond buyers through subscription, while S&P and Moody’s are paid by companies that issue securities.

Rally fizzled on Friday - as it should...

The looser guidance of the IRS drove a rally initially, but I think the market will back up. It's like the market found out a girl that it was hot for had just decided to become a prostitute, and it got excited about the imminent action, but after a roll in the hay has realized it can never take her home to see the parentals. She'll still come in useful in the future though.

Things simply aren't good either.

• CRENews.com had an article out summarizing the rating actions year-to-date: 3,405 CMBS Downgrades, Only 82 Upgrades. Keeping in mind that rating agencies are extremely reactionary by nature (rather than making calls on the future - just wait until we actually have widespread problems).
• PCV/ST is defaulting imminently, along with a number of other high profile loans that are not cashflowing. I'm calling for a December default on PCV/ST with an over/under of 1 month - bets are now being taken.
• European CMBS loans were structured in an inherently weaker fashion in many regards, but also have additional covenants that lead to defaults faster (to protect the investor). That market is unraveling a little ahead of the domestic market. Not too mention there was ruling recently in France that allowed a Lehman-owned office building to pursue a workout strategy - DESPITE the fact that the bondholders wanted to take over the already defaulted loan as would normally happen. They're rewriting contract law everywhere, to the detriment of real estate investors, it is not just a domestic issue!
• The IRS changes its mind all the time. I'll bet a small sum that 10-years down the road we'll be able to look back and talk about a REMIC that was broken up because of some loan mod they decided they didn't like.
  
• Not to mention that some current- and next-pay AAA bond holders are going to be up in arms over the new IRS guidance - They already are.
  
• Will TALF new issue be successful? It has some draw backs that make it even less interesting to investors than the legacy TALF, which frankly hasn't seen much demand because it was structured so poorly (on purpose) by NYFRB.
  
• If new issue TALF isn't successful, we're going to have problems. The first new issue TALF deal should be DDR's - they have $900mm CMBS loans maturing next year, and another $500mm in 2011.
  
• CMBS maturities are nothing compared to banks/thrifts, but some REITs have a lot of CMBS mortgage debt to roll (I still can't believe that idiot, Cramer, would tell you to buy REITs right now). The ones with the largest maturities (all are >$500mm) next year are, in order, GGP, Vornado, DDR, Simon, Colonial, and Regency.
• Looking at REIT CMBS loan maturities over the next 3 years that exceed $1 billion, you end up with a similar list: GGP, Vornado, DDR, Simon, Regency, and Brookfield. Brookfield is an addition to the list, and has the second largest maturity schedule ($3.6billion) due the mortgages it used in the Trizec acquisition back in 2006. It has another $2 billion or so of CMBS loans due after 2012 as well.
  
  

Capmark's only value was its servicing platform

Following Berkshire's offer to buy Capmark's servicing, Moody's downgraded the remaining firm to C.

Moody's said the sale would impair Capmark's remaining business and eliminate a stream of income key to repaying debt. The ratings agency also said Capmark's assets have continued to deteriorate in quality and its banking arm may need an infusion of capital, all while its portfolio of unencumbered assets has shrunk.

The really impressive part of the whole story is the talent of the journalist writing the story. No only did they misspell words (I made corrections in the above quote from WSJ), but they obviously did 100% of their research via Google. They note at the end of the article:

The company primarily works with commercial real estate, according to its Web site.

uhhh, has it really come to this? This is more disappointing than Bloomberg's little basis point definitions every time they use the words "basis point", in a financial news article, aimed at people who better know what a basis point is!

A basis point is 0.01 percentage point and is equivalent to $1000 a year on a contract protecting $10 million of debt.
A basis point is 0.01 percentage point.

Rating Agency's free speech argument challenged successfully

I know this is yesterday's news, but after I posted the video to Massive Attack's - Angle in my little link to Costar's excellent article on Mezz foreclosures, I ended up refocusing my efforts on listening to all the other Massive Attack songs on Youtube. I'm easily distracted.


Regardless, as the WSJ so aptly noted:

Moody's and S&P moved to dismiss the suit on free-speech grounds. The judge said ratings are typically protected from liability and subject to an actual malice exception because their ratings are considered matters of public concern. "However, where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is not afforded the same protection," the judge said.

This has always been their first round of defense when they screwed up a rating and someone lost enough money to sue them, and it looks like it might not work going forward. At the end of the day, their ratings are backward looking at best, and realistically their methods are so poor and inconsistent that they are sloppy at worst, and maybe even criminal. Just by natural selection, any decent analyst at an Agency will get snapped up by a Street side research group. Even the ones that I actually liked were burdened from expressing their opinions by their overlords both inside and outside their own bureaucracies.

Rating Agency Integrity

Without naming any names, the following is a quote from a recent rating action on a CMBS deal that demonstrates the continued failure of rating agencies.

Fitch analyzed the transaction and calculated expected losses by assuming cash flows on each of the properties decline 15% from year-end (YE) 2007 and property values decline 35% from issuance.

Are they telling us that they think cash flows will only decline 15% and that property values will only drop 35% since issuance? What kind of stress test is that?

They end up with 5% estimated losses on the deal, including a forecast on some of the maturity defaults. On the same deal, Citi is forecasting 10.3% losses over the life of the deal in their stress test.

Live Fast, Die Young

S&P managed to downgrade a bond from AAA to BBB- and back to AAA with in ONE WEEK!

Let's not even discuss the fact that the bond has a break-even default rate above 100% - i.e. default all the loans underlying it, and you still get 100% of principal back.

Rating Actions

Over 3,000 year-to-date! Compares to just over 1,000 for all of 2008, and less than 200 in every year prior back through the turn of the century.

CMSA Was Last Week

You didn't miss much. Mostly a lot of concern and disbelief over S&P's comments a few weeks ago regarding downgrades to the AAA stack. Especially IOs - heavy selling coming soon from insurance portfolios?? Insurance companies average about 10.1% of their CMBS portfolios in Support and PAC IOs.

Also some talk about the guidance on new issue TALF, with some looking for a dozen new issue deals by year end, starting in August. These will likely all be single borrower and large loan deals - we're likely to see a resurgence in the large loan fixed deals that have been dormant in recent years after being replaced by the Pari Passu structures seen in Conduit/Fusion.

S&P Delivers Another Right Hook

Under our 'AAA' stress, losses from this vintage range from 12.3% to 60.4%, but these loss rates are commensurate with an extreme economic downturn and do not represent our expected case.

Ten-year super-duper (30% credit-enhanced) classes have a higher potential for downgrades than the shorter weighted-average life classes. The ratings on older vintages (2000-2004), which were issued well before the peaks in valuations (2007) and effective rents (2008), and generally utilized stricter underwriting standards than more recent vintages (2005-2008), saw less downward movement on average in our analysis.

S&P Dashes Market Hopes

S&P basically came out today that they may downgrade more than half the recent vintage dupers, making them ineligible for the gubments TALF 3.0 plan. Surprisingly, it only sent A4 spreads 100 bps or so wider, but I imagine this plan will continue to unravel in an disorderly fashion.

It is likely that the proposed changes, which represent a significant change to the criteria for rating high investment-grade classes, will prompt a considerable amount of downgrades in recently issued (2005-2008 vintage) CMBS. Classes up through the most senior tranches of outstanding deals (so-called "A4s," "dupers," or "super-duper seniors") are likely to be affected. Our preliminary findings indicate that approximately 25%, 60%, and 90% of the most senior tranches (by count) within the 2005, 2006, and 2007 vintages, respectively, may be downgraded. We believe these transactions are characterized by increasingly more aggressive underwriting than prior vintages. Furthermore, recent vintage CMBS, particularly those issued since 2006, were originated during a time of peak rents and values, and as such, may be more affected by the proposed rental declines discussed in this RFC. We are currently evaluating the impact of the potential criteria changes on conduit/fusion CMBS transactions from all vintages. Once we evaluate the potential impact on existing ratings, we expect to issue a follow-up publication to this RFC.

Moody's completed downgrades

Following 7 days of correcting their ratings on 1,422 bonds worth over $50 billion, Moody's stated it was done with its review. The actions were highly anticipated for some time, and made for a volatile market the last two weeks.

Obviously, Moody's made a huge mistake - they are not downgrading these due to deterioration in quality, but rather due to changes in their model. And their new model is only calling for 5% losses on recently issued deals with the weakest credit profiles. Historical losses when times were good are 3%! I don't know how they are still in business.

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