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.
AMPING UP RISK
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
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
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
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
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.
USING CLO TECHNOLOGY
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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