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CRE Finance World, Summer 2013

• However, our analysis suggests that extension will not produce a material lift22 from the perspective of reductions in either overall default or loss rates for the CMBS universe, specifically under the conservative refinance parameters.23 The limited credit risk lift from loan extension is primarily due to a relatively flat forecast for property yields and values. Given the size of the marginal refinancing shortfall that could qualify for extension24 — particularly under the lenient extension scenario — dramatic fundamental property performance improvement would be necessary over a short horizon to make a significant difference. What Drives the Results? When we look at attribution — how much impact the three defining scenario factors (risk free rates, refinance parameters, and pass through rates) affected projected outcomes — we find that on a relative basis, the refinance parameters had the greatest impact on probability of default. When we consider expected loss, a higher pass through of rising interest rates to cap rates has the largest impact. Weighting the probabilities of the six scenarios equally, the relative impact of change amongst the three scenario factors break out as indicated below: Exhibit 10 The cumulative Refinance PD across scenarios25 Source: PPR, Trepp • Impact to Refi PD from changes in each of the three scenario factors. Refinance parameters have biggest impact on Refi PD on a relative basis. CRE Finance World Summer 2013 22 Exhibit 11 The cumulative Refinance EL across scenarios26 Source: PPR, Trepp • Impact to Refi EL from changes in each of the three scenario factors. Pass through rates have biggest impact on Refi EL on a relative basis. Naturally, we have only modeled a limited set of outcomes. The relative impact of these factors could be dramatically different under different assumptions. Conclusion There is legitimate concern regarding refinance risk in CMBS. In a higher rate environment, with more conservative underwriting parameters, and a greater degree of elasticity in valuation (relative to the risk-free interest rate), pronounced levels of refinance risk should be expected. Our analysis suggests that potential expected refinance loss is nearly four times higher should all three of these scenario factors come to fruition. Additionally, the impact of vintage is also evident — loans underwritten at or near peak market valuations will face more difficult refinancing probabilities than the overall universe. Refinance losses for the 2005–2008 vintages will be more than three times higher than those from the 2010–2012 vintages. Finally, extension could reduce loss levels for a small portion of loans on the margin, but would not materially change refinance loss levels under any scenario. CMBS Refinance Risk: Vintage Analysis Across Multiple Economic Scenarios


CRE Finance World, Summer 2013
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