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CRE Finance World, Winter 2013

Legacy CMBS Credit Outlook for 2013: Don’t Get Caught Swimming Naked Figure 4 2015-2017 period. On Dodd-Frank risk retention limits, the rules 2005+ Legacy Conduit Deals, Realized Losses need to still be clarified. Depending upon the outcome, we see risks that could reduce the number of B-piece buyers and liquidity of the new issue market. Current draft rules require 5% risk retention on all transactions. For CMBS, this can be satisfied by a qualifying B-piece buyer owning the below investment grade bonds, with a string of new conditions. These conditions include limits on any hedging or sale of the position. As a result, a B-piece buyer would have to commit to holding the bonds for 10+ years, without any ability to hedge interest rate risk or sell the position based on a change in view. Additionally, new disclosures will need to be made by the B-piece buyer, including the price paid for the securities and level of experience/diligence. Source: Bloomberg. Data as of November 16, 2012. We applaud efforts around risk retention and increased “skin in the game” but an overshoot of conditions on B-piece buyers could pose a Active versus Passive CCR threat to the recent recovery. Any disruption of the positive feedback As losses rise and control class shifts, credit investors face cycle emerged in the new issue market may have significant additional uncertainty. First, it could lead to a change in the CCR implications for the performance of legacy CMBS deals as we with potentially different strategies and/or motivations. From our approach a large volume of maturing loans. experience as CCR on 2 legacy CMBS transactions, there is a big difference between an active and passive CCR. An active CCR Summary may be incentivized to expedite loan workouts and resolutions, Given the broad-based rally in 2012, legacy credit poses less leading to a quicker pace of liquidations. “margin of safety” for investors in 2013. Historically attractive relative value opportunities still exist; however, effective security Additional uncertainty may occur if the special servicer changes as selection will be crucial to realizing strong returns in 2013 as we a result of the CCR. Special servicers can exhibit vastly different expect significant and more pronounced dispersion across deals. workout strategies, with some favoring a longer-term hold of REO A shift in the rising tide of liquidity and/or the CMBS specific factors assets versus others that tend to liquidate more quickly. A change we highlight could be a catalyst. Until this occurs, legacy credit in the special servicer can be disruptive to investors, as the workout investors should swim carefully and keep their trunks tied on tight. behavior could shift abruptly and alter expected cash flows. Across 2007 vintage CMBS deals, we have already seen at least 14 of 68 1 AJ refers to junior-AAA classes; originally rated AAA with average credit deals change special servicers; we expect this trend to continue. support of 12%, and average detachment point of 20%. This will require additional surveillance by credit investors. 2 REMIC rules required special servicers to sell an REO asset within 3 years of acquiring title; however, the servicer could petition the IRS for 4) More Clarity on Regulation, Status Quo an extension but historically this has been infrequent. Finally, we see risks to the new issue CMBS market around risk retention rules. With the outcome of the November elections behind 3 This represents the combined appraisal reduction amounts (ARA) on us, we should have more clarity on the path of future regulation. these REO assets. The ARA calculation haircuts the latest appraisal by The elections generally preserve the status quo and imply Dodd- 10% and factors in advancing/expenses. Frank risk retention limits and the Volcker rule on bank proprietary 4 “Looking for signs of a credit burnout”. Barclays Capital Securitization trading will likely be here to stay. Research, January 22, 2010 on www.barcap.com Any disruption to the new issue market, which has rebounded 5 Servicer watchlist codes 4A–4F. above expectations in 2012, will have a negative effect on legacy 6 Original B-piece stack refers to the below investment grade and non- CMBS, especially as we approach the wave of maturities in the rated classes at origination. A publication of Winter issue 2013 sponsored by CRE Finance World Winter 2013 27


CRE Finance World, Winter 2013
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