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CMBS market embraces increased risk again | Reuters

Nov 6 (IFR) - The US commercial mortgage-backed securities

(CMBS) market is once again embracing higher-risk collateral and

asset structures, which could pave the way for new commercial

real estate (CRE) collateralized debt obligations (CDO).

In late October, Citigroup priced a controversial

floating-rate CMBS for NorthStar Realty Finance, a REIT, with

high loan-to-value "transitional" collateral and an aspect of

future funding or "ramping up" that caused some investors to

question its structural categorization.

While the transaction was an offbeat CMBS, securitization

specialists say that the deal brings the market one step closer

to reviving CRE CDOs. Much of the transaction's collateral was

being ramped up, and the next step towards a CRE CDO revival

would be to include a so-called "reinvestment period", where

principal proceeds are reinvested in new collateral assets

(loans or debt securities).

A new CDO might also include legacy CMBS bonds as

collateral, in addition to static whole loans.

Citigroup and other broker-dealers have been actively

discussing the idea with various issuers, including NorthStar,

potentially eyeing a simple CDO structure in the months ahead.


The recent NorthStar CMBS hints at higher levels of risk as

well as growing investor comfort with more complicated products

in an attempt to earn more yield.

Only the fifth floating-rate CMBS to appear since the

financial crisis, the deal was the first of these to include

multiple loans, and the first to feature so-called

"non-stabilized" properties, which are either not fully leased

or sold, or not fully developed, and are therefore expecting an

increase in cash flow.

"The term sheet referred to the deal as a 'market-driven

CMBS 2.0 structure', though evidently collateral-wise perhaps

somewhat far afield of what one might expect to encounter under

that umbrella, maybe," said Christopher Sullivan, United Nations

Federal Credit Union's chief investment officer.

"But it was certainly representative of the evolution of the

CMBS market to date and what sort of deal structures are viable

or saleable."

The transaction reignited rating agency sniping over CMBS

criteria when Fitch last week said it would have rated the

senior tranche two categories lower than what it was given by

Moody's and S&P.

Both of the two larger firms gave the Class A tranche a

Triple A stamp but Fitch says it would have stopped at Single A

- even though it is underpinned by 56.5% credit enhancement.

Fitch said it was "concerned that a significant portion of

the collateral is sub-performing and transitional in nature,

with a reliance on borrower pro forma business plans to improve


It also worried about refinancing risk and "the high

likelihood of default at maturity, especially in a higher

interest-rate environment."

Because of this more conservative stance, Fitch said it was

ultimately not asked to rate the deal.

It gives the example of the largest loan in the pool, Buena

Park California, which accounts for 20.8%. Fitch deems the

shopping mall sub-performing and said it was concerned with low

market occupancy, the high number of temporary tenants and low

reported in-line tenant sales, as well as stiff competition in

the submarket.

Furthermore, the loan is open to interest-rate risk as it

does not have an interest-rate cap.

The agency said it had seen several sub-performing malls

with significant loss severities, in some cases exceeding 100%.

A second example provided by the agency is the Cranbrook

Multifamily Portfolio in Houston, accounting for 5.7% of the

pool. Fitch was concerned that the cash flow has not stabilized,

as overall occupancy has fallen below 50%. It also lacks an

interest-rate cap, and has additional debt in the form of a

mezzanine loan.

Four weeks ago Moody's said it would only have rated the

junior tranches of another CMBS, JPMCC 2012-C8, as junk, and not

investment-grade as S&P did.

And three weeks ago Moody's said it would not have gone to

Triple A for RBS's Isobel Finance UK trade, saying it was only

worth a Double A rating. In addition, it would have undercut the

Double A and Triple B plus ratings that S&P gave the issue by up

to three notches.


The US$227.54m NorthStar 2012-1 was backed by 14

floating-rate loans in a trust, linked to 19 properties. It was

structured as a so-called real estate mortgage investment

conduit (REMIC) -- not a grantor trust -- with no reinvestment


The initial pool balance was US$351m, with a 33.6% exposure

to retail, and the tranches ranged from a US$152.8m two-year

Triple A down to Triple B minus (Moody's and S&P). NorthStar

retained the bottom 35% of the structure.

The deal priced with a weighted average coupon of Libor plus


Moody's stressed that the loan-to-value (LTV) for the pool

of loans was 125.3% - the highest level observed by the agency

in CMBS 2.0. In fact 13 loans, or 98.6% of the pool balance,

exceed 100% LTV.

Moreover, several properties were in a highly transitional

phase of operating performance. In its presale report, Moody's

said it believed there was an increased risk that the properties

would not achieve stabilized cash flow relative to other

previously rated large loan transactions. Therefore, the Triple

A slice had very high credit enhancement.

In March, Citigroup completed a very similar CMBS for A10

Capital, a commercial mortgage lender specializing in so-called

mini-perm, or bridge loans, which was less than US$100m in size.

A10's transaction was "backed by a pool of bridge or

unstabilized loans," Rick Jones, a partner and co-chair of law

firm Dechert's finance and real estate group, wrote in the

firm's real estate blog in May.

"The structure was a melding of traditional CMBS and

collateralized loan obligation (CLO) technologies, which

balanced the sponsor's need to manage and nurture bridge product

while providing investors with substantial credit enhancement,

downsize structural protection and certainty. Some of the loans

included [in the A10 deal] had future funding components."

Arbor Realty Trust, a REIT, issued a similar deal in the

form of a CLO in September.

"Theorizing going forward, I think the next round of all of

these products will have some CLO features to them," said Matt

Borstein, managing director in Deutsche Bank's CRE finance


Market participants have been talking about resurrecting the

CRE CDO market for nearly two years, but it hasn't worked out


Prima Capital Advisers LLC tried to bring a US$670m CRE CDO

to market in July 2011 -- a fully-ramped securitization of

fixed-rate notes -- but it was scuttled at the time due to

overall investor skittishness due to the decision by Standard &

Poor's to pull a separate CMBS conduit just days before.

Deutsche Bank and Wells Fargo worked on the Prima Capital


CRE CDOs would offer more structural flexibility than CMBS

for loan aggregators, and far more yield for investors,

according to securitization specialists.

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