Monday, July 13, 2009

CMBS, the latest evidence of pain


In total, 12,853 loans with a balance of $158.6 billion are on watchlists. They were placed there for various reasons, chief among them is that they failed certain objective financial tests, namely those for debt-service coverage levels.

Loans originated in 2006 and 2007 account for an overwhelming share - nearly 65 percent - of the volume on watchlists. By balance, $47.7 billion of 2006 loans and $55.3 billion of 2007 loans are on the watchlists.

During those years, lenders regularly underwrote mortgages based on collateral properties' projected property cash flows, as opposed to actual cash flows. And those projected cash flows in many, and perhaps most cases, have failed to materialize.

The drop in cash flow resulted in debt service coverage ratio (the minimum ratio of cash available to the amount needed to pay interest and required principal paydowns.) What's interesting is that a large portion of the earlier commercial mortgages did not require principal amortization.

Source: Bloomberg

That means that in many cases there is barely enough cash to cover just the interest. For many of those loans, principal payment will come from the property liquidation. Needless to say all the new deals require a full or partial principal amortization - similar to a typical residential mortgage. But the new deal flow has collapsed, and there is little primary market to take out maturing debt. There is hope that TALF may help, but nothing of significance has been refinanced yet (see: So far no CMBS takers for TALF)

Deals outstanding by year of origination (Bloomberg):

In addition to the refinancing problem CMBS deals are facing, delinquencies in CMBS are now starting to creep up.

From Moody's:

Moody's thinks this will jump to 5-6%. Let's take a look at how that breaks down:

Multifamily delinquencies have been on the rise for some time now because apartment rentals are heavily linked directly to the more vulnerable consumer. More recently hotel and mall (retail) properties are showing signs of stress.

Not that ratings mean a whole lot, but it's interesting to see how the rating agencies are trying to catch up to "correct" the errors of the credit heyday by doing rapid-fire downgrades. Here is a chart from Bloomberg that shows upgrades and downgrades of outstanding CMBS:

And who were the originators that underwrote the deals with the highest delinquency rates? Well here they are:

From Bloomberg, sorted by the number of delinquencies (the columns indicate how late the borrowers are on their payments) :

The spreads on senior CMBS paper, though off their peak, continue to stay extremely wide - effectively at distressed levels.

CMBS spread to treasuries:

So far there is no end in sight for the stress in this market. On top of the worries over the refinancing cliff, delinquencies are creeping up. All eyes are now on TALF as the Fed is getting ready to transfer some of the risk to the taxpayer's balance sheet. From Reuters:

Most commercial mortgage-backed securities eligible under published guidelines for the Term Asset-Backed Securities Loan Facility will also meet other Federal Reserve criteria, the Fed told investors on Friday, according one investor and a dealer.

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