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CREFW-Fall2014 10.15.14

Behind the Cashout s we enter the final stretch of 2014, the deterioration of credit continues to be a concern. While some metrics such as leverage, debt service coverage and the increase in interest-only loans can be easily tracked on a deal-bydeal basis, others are more qualitative, such as location, rollover schedules, and time of ownership. In this report we focus on borrower equity cashouts, one of the options offered to borrowers in an increasingly competitive market. A cashout is any amount of proceeds leftover for the sponsor after earmarking for refinancing, reserves, capex and fees. In our conversations with investors, the slippage of key credit metrics coupled with equity returned to borrowers (hereafter referred to as an equity cashout) has been on the top of their list of concerns. As such, we sought to quantify the impact that equity cashouts have had in driving our main stressed metrics into riskier territory. In this report, we focused on the Top 20 loans in our KBRA rated conduit universe from 2013, through mid-year 2014, where equity has been returned to the borrower. In determining whether or not a cash out occurred, we eliminated recapitalizations of previously unencumbered properties. We utilized only metrics based off the in-trust first mortgage debt, although we did examine the prevalence of mezzanine loans within this universe, as detailed further below. Our total universe of Top 20 loans comprises nearly $40.0 billion on a balance basis, while the cashout universe is $16.5 billion across 391 loans. CRE Finance World Autumn 2014 46 Our main takeaway: slightly less than half of the loans in KBRA’s Top 20 universe have returned equity to the borrower. However, we also individually reviewed characteristics of the loans to gauge the story behind the numbers. Taking that into account, it is evident that a majority of the cashouts have occurred in loans where the borrowers have had long operating histories of at least five years and where equity has built-up in the property either through equity investments and/or asset appreciation. Nearly all these loans were used for refinancing. In the sections that follow, we delve further into these loans, by looking at both qualitative and quantitative attributes. Figure 1 Two Universes — Overall Stats In 2013, the characteristics of cashout loans closely tracked those of the universe, and in some quarters were better. However, as competition amongst lenders intensified in 2014, the credit metrics of these loans weakened faster than the broader universe. As one would expect, leverage for cashout loans deteriorated faster than the broader Top 20 universe, ending Q2 2014 at 104.3% compared to 101.4% for Top 20 loans. This differential was primarily attributable to the percentage of loans with KLTVs in excess of 100%, which was almost 10.0 points higher than the Top 20 universe in the first half of 2014, at 72.2%. Debt service coverage has maintained a healthy cushion even as leverage has increased, as the weighted average KDSCs for both the Top 20 universe and cashout loans was 1.73x. The percentage of loans with KDSC<1.20x was on average in the single-digits, however Q1 2014 was the outlier, where the percentage was the highest at 17.2% and 23.4%, for Top 20 and cashout loans respectively. Despite investors’ concerns, the percentage of loans with cashouts has actually declined over time. In the first half of 2014, as other metrics were weakening, borrowers received 20.0% of loan proceeds in the form of equity, down from 25.2% in 2013. A Terri Magnani Senior Managing Director Kroll Bond Ratings Nicoletta Kotsianas Associate Director Kroll Bond Ratings “Our main takeaway: slightly less than half of the loans in KBRA’s Top 20 universe have returned equity to the borrower.”


CREFW-Fall2014 10.15.14
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