Legacy CMBS Credit Outlook for 2013: Don't Get Caught Swimming Naked

CRE Finance World, Winter 2013

Legacy CMBS Credit Outlook for 2013: Don’t Get Caught Swimming Naked Aaron K. Bryson CFA, Principal Spring Hill Capital Partners, LLC T credit performance in 2013. These risks are likely to bring •servicers — leading to reduced liquidations and increasingA continuation of “kick the can” strategies by most specialIn addition, there were several factors specific to CMBS that aidedthe recovery, including:he 2013 year promises to be more challenging for legacyCMBS credit investors, after nearly across-the-boardprice appreciation in 2012. After a brief review of 2012performance, we highlight four potential tailwinds to credit analysis and security selection back to the forefront as a driver amount of modifications on larger loans of return, much more so than in the prior year where exogenous macro issues and a rising tide of liquidity lifted nearly all credit bond ° despite steady increase in delinquency pipelinesRealized losses remained low/credit support remained high, prices higher. We expect greater price tiering and dispersion across deals in 2013, providing both potential opportunities and pitfalls for •Growing appetite for legacy credit bonds from both investors and investors. Security selection will be critical; to paraphrase Warren dealers, which allowed increased supply to be easily absorbed Buffett, don’t get caught swimming naked when the tide goes out! ° Two large CRE CDO liquidations saw an additional $3.1 billion of 2012 Review AJ supply floated into the market in 2Q 2012, which paradoxically The 2012 year was strong for legacy CMBS credit. For simplicity, brought new entrants to the market and enhanced liquidity we define legacy CMBS credit as 2005+ vintage AJ1 and below conduit bonds, with a focus on the AJs as an overall barometer. •Above consensus rebound in new issue CMBS supply and the beginning of a positive feedback cycle for CRE lending/pricing We entered 2012 at depressed valuations, following a late 2011 slide which saw indiscriminate selling pressure and pushed prices to ° Improved refinancing results for the large amount of 2012 fundamentally cheap levels. Combined with a steady yet unspectacular maturing loans, downward pressure on cap rates, and improved CRE recovery, global central bank induced liquidity, and a search outlook for the wave of 2015–2017 legacy maturities for yield across fixed income credit products, we saw an impressive rally in 2012 and strong demand technicals. According to JP Morgan, The price rally in 2012 was in some ways a mirror opposite of the legacy CMBS AJs rallied by $15 points, or 27%, over the YTD slide in late 2011. We saw almost universal price appreciation in period through November. Notably, prices rose by double digits legacy credit in 2012, as increased liquidity and the search for yield + even across weaker quality AJs; we saw similar moves further led to a rising tide which lifted prices on even weaker credit bonds. down the capital structure. 2013 Outlook Figure 1 As we head into 2013, many of the same macro factors remain Legacy AJ Price Rally firmly in place. The election outcome likely leads to a prolonged period of aggressive monetary stimulus and lower interest rates, forcing fixed income investors to continue to search for yield. Across fixed income credit products, structured products — including select legacy CMBS bonds, continue to offer attractive relative value and structural protection. By the time of the January 2013 CREFC Conference, hopefully we have a resolution on the fiscal cliff. But, regardless of the outcome, the inevitable consequence is a prolonged period of fiscal austerity that will reduce potential economic growth and place pressure on commercial real estate fundamentals. This fiscal drag will at least partially offset the impact of aggressive monetary policy, Source: JP Morgan, data through November 16, 2012 unlike in 2012. CRE Finance World Winter 2013 24


CRE Finance World, Winter 2013
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