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CRE Finance World, Summer 2013

A publication of Summer issue 2013 sponsored by CRE Finance World Summer 2013 69 The importance of property-level cash flow — and the ability for the special servicer to capture it — can also be observed by looking at the cash flows or properties at the time of their transfer to the special servicer. The chart above shows the percentage change in cash flow since issuance for all liquidated loans at the time of their transfer. In a clear relationship, the steeper the cash flow decline, the greater the liquidation expenses. A more relevant comparison would be the decline in cash flow from issuance to time of liquidation but, as previously stated, updated cash flows during the liquidation period are essentially non-existent in the IRP. Given the sensitivity to property cash flows, it follows that as cash flows in the CMBS universe continue to improve, liquidation expenses should also trend downwards, resulting in lower loss severities. Conclusion As anticipated CMBS 1.0 loan maturities near investors should consider elevated numbers of modified loans, specially serviced loans and loans with obvious refinance risk given their relatively low debt yields. At the same time, the research above presents two relevant mitigating factors. First, most loans benefit from positive seasoning, and the loans in legacy CMBS that are currently outstanding have weathered the worst of storms. Second, and most importantly, property-level cash flows are growing again. While the frequency of loan defaults is a separate consideration, this paper suggests an increased probability that the loss severities of the loans that mature through 2017 will be less than the severities observed during and immediately preceding the Great Recession of the late 2000’s. 1 DBRS defines “value decline” as the difference between the reported issuance appraised value and the liquidation price (before liquidation expenses). 2 By “market liquidity” DBRS refers to the general availability of capital. We measured it using the number of American Council of Life Insurers (ACLI) originations as a proxy for CMBS market liquidity. The number of CMBS loan originations had roughly the same correlation with loss severity as did the number of ACLI originations, but the ACLI data was more consistent through time, likely a result of the relative maturity of that lending market and the stability of its participants. Market liquidity is an important consideration for refinance default risk. 3 The majority (91%) of the losses within our dataset come from the period after the Great Recession (2009 onwards), making it difficult to measure the impact of the 2001–2002 recession on loss severity trends. While the 2001–2002 recession had a notable impact on unemployment it remains the only recession since the 1960’s that did not broadly coincide with a drop off in CRE liquidity (as measured by the number of ACLI originations) 4 DBRS’s market index is an indicator that combines demographic profiles by zip code, U.S. Economic Census data and CMBS data, to estimate the depth of the CRE market in a given zip code. The market index ranges from 1 to 7 with 7 being the more dense urban, liquid markets, and 1 representing the more rural, illiquid markets. 5 Defaults and Losses on Commercial Real Estate Bonds during the Great Depresssion Era, Tyler Wiggers & Adam B. Ashcraft, Federal Reserve Bank of New York Staff Reports, page 29. 6 For statistics on liquidation time, the dataset only includes those loans that were liquidated. The inclusion of loans that were previously specially serviced, transferred back to the master and either paid down (without a loss) or are currently outstanding, may alter these conclusions in future studies. 7 DBRS defines years of distress as those years that saw CRE cash flows decline on average in our data set, specifically 2002 and 2003, and 2009 and 2010. Net cash flow change by property type chart excludes property types that had fewer than 1,000 observations of cash flow change. 8 As defined by the CREFC IRP Realized Loss Template Anatomy of a Loss “Our research presents two compelling mitigating factors: First, most loans benefit from positive seasoning, and the loans in legacy CMBS that are currently outstanding have weathered the worst of storms. Second, and most importantly, property-level cash flows are growing again.”


CRE Finance World, Summer 2013
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