This may be no country for old men, but it’s definitely no market for little boys.
The headlines on February’s mortgage delinquency numbers were either negligible or somewhat alarming, depending on who reported them and the comparisons they were using. The biggest surprise in all the data was the increase in multifamily delinquencies, which is traditionally the safer and less volatile of the four real estate “food groups”. Here is a look behind some of the data.
A majority of the increase in multifamily delinquencies are linked to just one borrower, New Orleans-based MBS Companies. MBS has a checkered past and was attempting a comeback in Texas. The Company aggressively overpaid for its assets and then severely under-managed them.
Market participants involved in the sale of some of these defaulted loans indicated that MBS was almost inept. Despite some well-located properties, they said that some on-site property managers were accepting cash rent payments and under-reporting occupancies to MBS management (so they could line their pockets with said cash) and maintenance was not even an afterthought.
As of the end of 2007, MBS had over $900 million in multifamily loans that were either delinquent or in foreclosure. The Company raises equity from individual investors (OPM) and generates earnings through fees and carried interests. Thus, their earnings are decoupled from asset cash flows and not aligned well with either investors or lenders.
Most of the loans were originated by PNC Bank’s Midland Loan Services unit, and then securitized. Midland remains the “special servicer” on many of these loans. Because Anthracite Capital (AHR) reports a close relationship with Midland in its SEC filings, this could be something to watch for with respect to AHR.
Given the size and diversity of AHR’s portfolio however, MBS is likely not much more than a fly on its elephantine behind. Other investors that own the below investment grade tranches on these loans are JER Investors Trust (JER) and Centerline (CHC) – though Centerline is not a REIT, and neither is as exposed as Midland.
Meanwhile, the first three months of 2008 ended with only $6 billion of domestic CMBS issuance, the lowest first-quarter volume in a decade. Given current lending volumes, it is unlikely CMBS issuance will even reach half of 2007 volume and some are predicting less than $60 billion for the year.
A liquidity vacuum still exists in this market, despite current BBB CMBX spreads of 1100 of 1200 basis points. Believe it or not, these spreads are actually in from about 1500 basis points before the Fed bought Bear Stearns and dropped rates yet again, all in the same day and on a weekend, no less.
It’s only a matter of time before these incredibly high, unprecedented spreads combine with the Fed’s largesse and the fundamentals of the commercial real estate market to over take short-term speculators in the CMBX.
With respect to delinquencies, according to the research firm Real Point, the delinquent unpaid balance for CMBS rose to a trailing 12-month high of $3.48 billion through February 2008, up from $3.16 billion a month prior. On its own, this is an alarming number, but doesn’t fully represent the breadth of what is a really a fairly placid and benign market, at least in terms of delinquencies
While it’s true that delinquent balances jumped 57%, from $2.21 billion to $3.48 billion, there is almost $815 billion in CMBS debt outstanding. Thus, even with a 57% rise in delinquencies, troubled loans still represent less than half of 1% of the total market, and CMBS delinquencies overall remain at historic lows.
The real story in the Real Point report is that the increased delinquency rate came primarily from two of the most recent, less seasoned vintages of CMBS. According to their research, over 40% of delinquent unpaid balances through February 2008 came from transactions issued in 2005 and 2006. Nearly 22% of all delinquencies came from the 2006 vintage alone. Almost seven percent of all delinquencies came from the 2007 vintage.
What is the significance of all this for Mortgage REIT investors? Stick to the seasoned veterans. Those who came late to the game have been hit the hardest and will take the longest to recover (if some of them ever do) because they bought at a time when underwriting standards suffered badly, and they stuffed their portfolios full of weak, demand-driven paper.
Chris Milner, Anthracite’s CEO, punctuated the point in his Q4 earnings release: “The dislocation in the capital markets continued to worsen in the fourth quarter, causing CMBS spreads to reach unprecedented levels. While this development clearly has resulted in negative price changes in our portfolio, the relatively better performance of our non-U.S. and seasoned vintage U.S. CMBS assets muted the overall impact.”
In Wall Street’s latest game of grown-up musical chairs, it would be wise not entrust your investment dollars to those little boys who sat down last.
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Disclosure: Long AHR at the time of publication