The New CMBS
Tom Acitelli Nov. 24, 2009, 7:05 p.m.
The slumbering giant of commercial mortgage securitization has been roused. Five months after the formal expansion of the Term Asset-Backed Securities Loan Facility, or TALF, to commercial mortgage-backed securities in June, the Federal Reserve Bank of New York announced last week that it had received its first requests for loans in support of new CMBS investment. Absent any new deals in the marketplace, loan requests up to now have been limited to credit in support of investment in older, legacy CMBS issues.
The first funding requests for new CMBS coincide with the pricing of series 2009-DDR1 certificates, a single-borrower, single-loan transaction brought forth earlier this month by Goldman Sachs Commercial Mortgage Capital. Details of a second deal became public last Thursday when Bank of America announced a $460 million CMBS issue, denoted 2009-FDG. Like DDR1, the Bank of America issue is purported to be a single-borrower, single-loan transaction secured principally by 44 office and industrial properties owned by Fortress Investment Group. While DDR1 qualified for TALF, Reuters and The Wall Street Journal have reported that the Bank of America deal will not be eligible.
The TALF funding requests for new CMBS, totaling $72.2 million, are a modest sum compared to legacy CMBS requests that have run into the billions of dollars since the New York Fed’s window expanded in July to include legacy issuance. Still, as the first new issue under the auspices of TALF, DDR1 has been received with cautious optimism in a market thirsty for new sources of credit. At a minimum, TALF is no longer terra incognita for other REITs planning the foray. As far as implications for broader liquidity, the market has been more reserved in its assessment of DDR1. In fact, spreads on AAA-rated CMBS widened after the deal’s announcement, rising by approximately 25 basis points before falling back last week.
While some market participants have hailed the new deal as a harbinger of robust securitization activity in the coming months, the implications of forthcoming deals for the broader commercial real estate credit market are not as clear as the current enthusiasm suggests.
In key respects, DDR1 is unlike the CMBS that the market had grown accustomed to before the downturn. It is of no surprise that the deal’s underwriting is markedly more conservative than its antecedents. But at the same time, the parties to the transaction and the underlying debt itself are somewhat removed from the locus of the commercial real estate credit crisis. DDR1 is by no means the perfect borrower: Its issuer debt rating was downgraded by Fitch to BB with a negative outlook in May. Still, DDR1 succeeds precisely because it does not overlap with or directly address the most pressing challenges in today’s financing market. Nor does its structure countenance the full extent of agency and information asymmetry failures that still sully investors’ appetite for fusion CMBS.
As of presale, the $400 million issue includes $323.5 million in Class A AAA-rated bonds. The issuer-reported debt-service coverage and loan-to-value ratios are 1.93 and 51.7 percent, respectively. These margins provide a much larger cushion for deterioration in cash flow and value than was the case for issues from the cycle’s upswing. Securing the debt, the issue is supported by 28 retail properties, ranging in size from just over 50 thousand square feet to just under 1 million. The observable vacancy rate of the properties varies from 0 percent to more than 25 percent.
As compared to the large fusion deals from years past, DDR1 is relatively much smaller, both in terms of its principal balance and the number of properties. These features lend themselves to a far more tractable analysis: The relative transparency of the deal lowers the investor’s own cost of information gathering and investment assessment, tempering his or her reliance on the ratings agencies and limiting the potential for untoward transfers of risk.
While conventional approaches to risk assessment will point to the risks of borrower concentration and sector concentration, the absence of diversity in these dimensions of DDR1 is among its strengths, at least as concerns its ability to attract investor interest. Without a large number of borrowers across a range of property types, the deal is less opaque, and information gathering is less costly.
Given that many of the mechanisms for assessing and communicating risk have been undermined by the last two years’ developments, the minimization of these sources of investor anxiety will be important in bringing future deals to fruition. This will be particularly true when investors are finally asked to take up deals that rely on the market’s own capacity to determine its equilibrium.
In facilitating DDR1, the parties to the deal have undoubtedly helped our industry take an important step forward. But characterizations of the deal as a breach of the securitization floodgates whereby all boats will rise are not likely to bear out. The principal impediments to the fusion deals and small-balance transactions that might alleviate some of the market’s most significant strains are de-emphasized by this highly facilitated, single-borrower, single-loan transaction where few real market-clearing mechanisms are at work.
This deal structure reflects that we have yet to address the challenges of agency, information asymmetry and incentive misalignments that have suffused some aspects of the securitization process. Until those challenges are taken up, we should not expect a resurgence of investor demand for deals that will alleviate broader credit constraints. Some industry participants have derided the most recent efforts by the House to address the problem, suggesting that we have a way to go.
Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.