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CRE Finance World, Autumn 2013

Canadian CMBS: “Low Hanging Fruit” For U.S. Fixed Income Investors Chris Kane A publication of Autumn issue 2013 sponsored by CRE Finance World Autumn 2013 21 anadian CMBS investors are a very happy group. And no wonder — it can’t really get much better. Canadian CMBS has a pristine credit record, with only 0.087% of cumulative losses from market inception (1998), and a current delinquency rate (0.27%) that is lost in rounding. It pays on time — 98.1% (by dollar value) of all Canadian CMBS loans have repaid at or within 120 days of scheduled maturity. Furthermore, Canadian CMBS has been “stress tested” — Canadian CMBS investment grade bonds proved to be far more resilient to the 2008–2009 financial crisis, and recovered their value much more quickly than U.S. CMBS bonds and many other credit products. On top of everything else, the new issue Canadian AAA and A CMBS are currently trading at a discount to U.S. CMBS bonds (with up to an 18 to 34 bp pickup in spread to investors). For fixed income investors, Canadian CMBS is an attractive risk-adjusted investment. Unfortunately, in the past most U.S. investors missed this opportunity. The primary culprit was Canadian withholding tax which, for many years, made investment by U.S. investors in Canadian CMBS investment grade bonds highly uneconomic. While many U.S. investors wanted to buy these bonds, this tax was simply too punitive. However, today things have changed. First, this withholding tax was eliminated as of January 1, 2008 with the passage of the Budget and Economic Interpretation Act, 2007 (Canada) . As a result, U.S. investors can now participate in the Canadian CMBS market without any tax disincentive. Second, after three years of hiatus (2008-2010), new Canadian CMBS issues are coming back into the market, with four new deals (including three since July, 2012) and more on the way. Our review of the key CMBS credit metrics of these new Canadian issues indicates that they are as good as, or better than, the legacy Canadian deals that have performed so well. For U.S. investors, or frankly any non-Canadian investor, who wishes to diversify their portfolios, new issue investment grade Canadian CMBS is truly the “low hanging fruit” in this market. Current Universe of Canadian CMBS To date, there have been a total of 67 Canadian CMBS issues since market inception in 1998, for a total issuance of $24.87 billion involving 3,706 (Canadian only) commercial mortgage loans. Historically, Canadian CMBS originators and issuers have included Merrill Lynch, TD Bank, RBC, CIBC, Column, GE, GMAC, Laurentian Bank, BNS and First National Financial (as direct participants or sponsors). Of all issuers, Merrill Lynch led the overall market with a 42% market share. Since the re-opening of the Canadian CMBS market in 2011, Institutional Mortgage Capital Canada (IMC) is the current market leader. IMC has an active CMBS origination platform with over $900 million of new loan originations since 2011, and has sponsored three new CMBS transactions for a total of approximately $700 million. Two other participants have established CMBS origination platforms with one (CMLS Financial) bringing its initial $249 million CMBS issue to market in 2012. As of August 1, 2013, the current outstanding balance of all Canadian CMBS deals (both legacy and new vintages) is approximately $10.85 billion, with 25 of the legacy CMBS transactions having been repaid and retired. Exceptional Credit Performance The overall credit performance of Canadian CMBS has been exceptional: • Cumulative losses for all Canadian CMBS transactions since 1998 have been less than 0.087% ($21.5 million) based on the total issuance of $24.87 billion. No Canadian CMBS investment grade bond has suffered a loss — ever! By any measure, this loss experience is truly remarkable. To date, U.S. CMBS has experienced cumulative losses of more than $27 billion or 2.87%, a loss rate more than 30 times the Canadian loss rate. • 2,190 Canadian CMBS loans have matured since market inception and 99.95% of these loans (by dollar value) have been repaid in full; only 2 CMBS loans have matured and not been repaid as of this writing; 98.1% (by dollar value) of all Canadian CMBS loans repaid at loan maturity or within 1–4 months thereafter. • Of the 386 investment grade principal bond classes in the universe of the 67 Canadian CMBS conduit transactions, only two classes (the BBB and BBB- bonds in the MLFAI 2001-Canada 5 deal) have ever been downgraded by all agencies rating the bonds and both of those classes repaid on time and with no loss to those investors. Of the remainder, there has been only a handful of downgrades and, in each case, by only one of the agencies which rated the transactions; primarily due to a change in rating methodology by one agency. C Managing Director, Principal Institutional Mortgage Capital Canada Doug Klaassen Partner Stikeman Elliott LLP Charles Gamm Vice President Institutional Mortgage Capital Canada


CRE Finance World, Autumn 2013
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