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CRE Finance World, Autumn 2013

Losing More than Your Loan Understanding Extreme CMBS Loss Severities “You effed up. You trusted us.” —Otter, ‘Animal House’ 1978 ith CMBS loss severities increasing and the largest CMBS loan origination vintages of 2005–2007 approaching their maturity windows, this paper examines extreme CMBS losses, including: what characteristics they share, what could have been done to avoid these losses and what lessons can be learned. The 2005-2007 vintage is considered by many to reflect the most aggressive underwriting standards in CMBS history and some of the trends noted herein are alarming and have led to predictions of CMBS cumulative losses as high as 14% in certain vintages which could create losses to “AJ” classes of bonds originally rated AAA at issuance. Despite a gradually improving economy, the unevenness of the recovery has left many assets in secondary and tertiary markets without viable business strategies. Stronger and better capitalized competitors have taken tenants from these weaker assets, thereby accelerating their demise. For those assets in rapid decline, time has been a critical factor in determining asset survival or extinction, often with material consequence to the CMBS trust. Background As illustrated below, while CMBS delinquency rates have declined modestly from their peak of 10.4% in July 2012, these rates remain stubbornly high from an historical perspective at nearly 9%. Of perhaps greater concern is the increase in loss severities for liquidated loans, particularly in the 2005–2008 vintages. Table 1 CMBS Delinquencies and Loss Severity Source: Citi group, Moody’s Investor’s Service *Excludes losses <2% (share of balance at resolution) Further, when considering historical issuance, particularly for the peak origination vintages of 2005–2007, and the more than $400 billion of CMBS debt that contractually matures between 2014–2017 (see below), the rate and volume of delinquent loans CRE Finance World Autumn 2013 26 and attendant losses has the possibility of significantly exceeding historical standards. Table 2 CMBS Issuance and Estimated Maturities ($billions) Source: Bloomberg Commercial Mortgage Alert Table 3 Selected Historical Loss Severity by Property Type ($billions) Source: Moody’s Investor’s Service and Trepp, LLC Having analyzed the largest dollar losses within the CMBS universe as well as realized loss severities in excess of 100% of original face, we have developed a “top five” watch list of considerations for what can go wrong in a CMBS transaction and how to potentially avoid or mitigate these kinds of losses going forward. #1 — Beware of Specialty Assets As noted in the chart below, specialty assets, particularly retail and hotel, account for the largest realized loss severities of all asset classes. This is not terribly surprising as these assets are more closely related to operating businesses with more volatile earnings than traditional real estate. Further, the myriad of co-tenancy clauses at many retail properties, coupled with the economic success of the in-line stores being closely tied to the health of the property’s anchor tenants, can rapidly accelerate the demise of a retail property when it loses a key anchor tenant to bankruptcy, often setting off a negative chain reaction. W Edward L. Shugrue III Chief Executive Officer Talmage, LLC


CRE Finance World, Autumn 2013
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