The Freddie Mac K Program: Quality, Stability, Liquidity

CRE Finance World, Winter 2013

Legacy CMBS Credit Outlook for 2013: Don’t Get Caught Swimming Naked “We expect greater price tiering and dispersion across deals in 2013, providing both potential opportunities and pitfalls for investors.” 1st AJ to Take Principal Loss? about loans with large tenant rolls in weaker sub-markets, where This drop in credit support will be felt disparately across deals and demand can be sporadic and the availability of competing space could lead to some negative technicals. We expect 2013 to be the remains high. Often, these loans do not have adequate reserves or first year that a legacy AJ takes a principal writedown. There are much cushion for turnover. The hotel sector, which represents daily multiple candidates for this dubious distinction, as 18 2005+ legacy lease turnover and is most susceptible to a change in economic AJs were experiencing interest shortfalls as of mid-November. conditions, represents nearly 10% of the legacy 2005+ vintage universe. The lumpy nature of CMBS collateral means these risks Our best guess for the first AJ bond to take a loss is MSC will be felt disproportionately across deals, unlike in RMBS; security 2007-HQ13, a bond with 8.4% current credit support. Based on selection will be critical. the latest appraisal value for the largest loan in the deal, $80.5 million The Pier at Caesar’s we expect a small loss to the AJ upon One recent example is the $71.2 million Millennium in Midtown liquidation of this asset. This asset has been REO with the special loan (2.6% of GSMS 2006-GG6), backed by a 411k sf office servicer, C-III, since October 2011, and has been listed for sale building in Atlanta, GA. This loan had a nearly 6-year constant-pay on Auction.com on multiple occasions. The servicer has stopped performance history until November 2012, when the loan became advancing on the asset as future advances have been deemed 30-days delinquent. Reported financials had been strong, with a non-recoverable. YE 2011 DSCR of 1.81X at 97% occupancy. The largest tenant, Price Waterhouse Coopers –which occupied 37% of the building, Credit Burnout is Real, But Idiosyncratic Risks Remain failed to renew its lease in October 2012. Servicer comments suggest this led to the default; the loan had been on watchlist The optimistic view would hold that the exit of weaker loans in for the past year. the pool and a reduction in the delinquent loans should offset the lack of credit support, and there shouldn’t be a negative impact 3) Out of Control? on pricing. This is a variation of the credit burnout phenomenon, commonly used to describe performance in non-agency residential The pickup in realized losses in 2013 will lead to further shifts in loan pools. As described by Barclays Residential Credit Team4, control, causing more special servicer migration and uncertainty credit burnout is described as: around loan workouts. As losses rise above the original B-piece stack and through the lower original investment-rated bonds largely “The mortgage pool goes through a difficult period and worse held in CDO’s, we will see new controlling class holders with credit borrowers default out of it, leaving behind better borrowers, different incentives and motivation6. This may have a destabilizing who perform better if left to withstand pressures smaller than, or impact on legacy credit performance. similar to, what they witnessed during the difficult period.” In legacy CMBS deals, control rights work from the bottom up, based We believe the credit burnout phenomenon is real, but believe the on realized losses, not appraisal-based estimates. At origination, impact is not as significant in CMBS pools as in RMBS. Stable the controlling class representative (CCR) is the B-piece buyer, performance history for 5+ years, especially through a severe who in many cases was also the special servicer on the deal. financial crisis, reduces the future probability of default, especially Typically the CCR has the right to consult on loan workouts and for amortizing loans where the borrower is slowly deleveraging. appoint/replace the special servicer. Despite the rise in delinquencies, However, in CMBS, idiosyncratic shocks still remain, especially the original B-piece buyer is still the CCR on the majority of legacy around large tenant lease expirations in the office, retail, and deals. Across the 192 2005+ CMBS deals, we count 127 deals industrial property types. Across 2005+ vintage deals, we see over where losses have not yet reached original investment grade $30.6 billion of loans, or 7.7% of all loans, on servicer watchlists for classes and eroded the original B-piece. We expect this number lease rollover, tenant issues, and vacancy5. We remain concerned to steadily increase. CRE Finance World Winter 2013 26


CRE Finance World, Winter 2013
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