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CRE Finance World, Autumn 2012

CMBS Opportunities: Any Floating-Rate Port in a Storm The Case for Front-Pay CRE CDOs short duration. As with the large loan pooled floating-rate CMBS Another overlooked area of focus for us is the front-pay CRE CDO transactions, for CDOs past their reinvestment date, their collateral market with an emphasis on whole-loan transactions and non-CUSIP has paid down to a handful of assets that are relatively easy to CDOs (meaning, CDOs comprised of whole loans, Mezzanine loans underwrite and offer compelling short-term investments correlated and B-Notes) that have passed their reinvestment period and have to one or two underlying transactions. begun to sequentially amortize. Following the financial crisis, there is almost no dirtier word than CDO. Most CRE CDOs have been Conclusion significantly downgraded since issuance and many are rated below Given the historically low interest rate environment and given the investment-grade. Further, many classes of CDOs are held by premium dollar prices currently associated with fixed-rate conduit Structured Investment Vehicles (SIVs) that have either been seized CMBS, Talmage is bullish on floating-rate CMBS securities for five or are being liquidated. All of these factors allow most CRE CDOs primary reasons: to trade at compelling discounts. 1. Floating-rate CMBS are effective inflation hedges that capture From a diligence perspective, we have focused on whole loan upside in an increasing interest rate environment; CDOs as a proxy for conduit transactions but with greater credit enhancement levels and lower dollar prices. Additionally, when 2. Floating-rate CMBS are one of the last remaining CMBS underwriting a CRE CDO, we carefully review the collateral manager, securities that can still be purchased at a dollar price discount, their actions and reporting. In this regard, we target certain issuers providing potential asset upside (on offense) and protection who are particularly thoughtful and aligned managers and who against price depreciation in an increasing rate environment continue to have “skin in the game.” An additional benefit of CRE (on defense); CDO transactions is that in most instances when they fail their interest coverage and overcollateralization tests, all of the CDO’s 3. Floating-rate CMBS in single borrower transactions and smaller excess principal and interest (including interest otherwise due to pooled transactions allow for high precision underwriting, PIK-able classes) is directed to the front-pay bonds until the earlier essentially allowing the sophisticated investor to buy real estate of their repayment or the tests being cured. cheaper on Wall Street than on Main Street; Chart 5 4. Floating-rate CMBS typically offer a shorter, more defensive ROCK 1 CRE CDO 2006 Capital Structure ($Millions) duration of three-to-five years, as opposed to longer-dated Floating Rate CRE CDO Transaction fixed-rate assets; and 5. Multiple arbitrage opportunities exist in a more pronounced manner for floating-rate CMBS than in conduit transactions in terms of ratings actions, capital structure and information. Since the floating-rate CMBS market is dwarfed in size by the fixed-rate conduit market and since most dedicated CMBS buyers, such as life insurance companies, tend to prefer fixed-rate CMBS to better match up with their liabilities, floating-rate CMBS assets tend to be overlooked and can present nimble investors with excellent relative and absolute value. In a sea of richly-priced paper, floating-rate CMBS provides a welcome port in a storm. Edward L. Shugrue III is the CEO of Talmage, LLC (“Talmage”). Talmage, and affiliates, is an independently owned and operated commercial real estate investor, special servicer and advisor created in 2003. Since its Source: Trepp/Talmage formation, Talmage has made in excess of $10 billion of real estate debt investments, acted as the special servicer or Operating Advisor on over As noted in the table above, we are attracted to Prudential’s “Rock 1 $10 billion of successful CMBS resolutions and has had an advisory role CRE CDO” due to the thickness of the A1 class, its robust credit in over $30 billion of such transactions. Talmage is headquartered in New enhancement, thoughtful management, asset quality and anticipated York City. www.talmagellc.com CRE Finance World Autumn 2012 30


CRE Finance World, Autumn 2012
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