Blackrock, one of the world’s largest bond fund managers, has also backed up the truck on CMBS. The value in CMBS is an intriguing story, and you should check out Deal Junkie if you want to know more about the fundamentals in commercial real estate.
“We didn’t know where real estate values were headed but we could clearly see there was value in the debt,” Jassem said. Meanwhile, spreads on AAA-rated commercial mortgage-backed securities are at record levels, and the CMBX continues to forecast a grim future of enormous bread lines and rattling tin cups.
So what gives? Why is the State of New Jersey and others stepping in where so many fear to tread? The reason is that the fundamentals are just not as bad as the CMBX and AAA CMBS imply.
Actual delinquencies remain low, and while I have written previously about the number of interest-only CMBS loans coming due in the next several years, it’s also true that the overall number of loans coming due in the next couple of years will also be somewhat low. This is giving many investors reason to believe.
According to JP Morgan, of the more than $600 billion of outstanding CMBS fixed-rate debt, only $16 billion is scheduled to mature in 2008 and $19 billion in 2009 (for a total of $35 billion). Scheduled maturities of fixed-rate CMBS debt reach peaks of $98 billion in 2015, $128 billion in 2016 and $127 billion in 2017. 65% to 85% of those loans are interest-only for the entire or partial term. As for the near future, 80% of the loans maturing in 2008 and 2009 have been amortizing over the full term, significantly bettering the odds that these loans can be refinanced.
Unfortunately, however, there is also some bad news: Wachovia has identified $30 billion of large-loan floating-rate deals that mature before May 2009, the majority of which were originated in 2006 and 2007. These were the go-go years and high profile defaults in several 2007-vintage loans were what caused much of the recent spread contagion. Wachovia also says that 95% of those loans have extension options, although it remains to be seen whether borrowers will be able meet the terms necessary to extend them (minumum LTV, DSCR, etc).
As far as defaults go, the delinquency rate on CMBS still remains low (for now). Fitch’s loan delinquency index was only 0.45% at the end of September. This is only slightly above the historic low of .27% (set in January of 2008). Currently, only 488 loans, totaling $2.5 billion in unpaid principal, are delinquent. This is small potatoes compared to the $562 billion in Fitch’s rated portfolio (which consists of over 40,000 individual loans).
Fitch also reported an additional 246 nondelinquent loans that are in special servicing due to imminent default or other nonmonetary reasons, and while not all of them will become delinquent, if they did the delinquency rate would double to .90%. This would still be only slightly above the historical average of .78% to .79%.
As I’ve written about ad-nauseum already, 2005-2007 loans will certainly bring challenges. Not only did originations in those years dramatically exceed the volume of previous years, but underwriting standards across the commercial real estate industry eased just as property valuations peaked and loans were increasingly written with interest-only provisions as noted above.
Historically, CMBS deals see defaults peak in years 3-8, with most of those coming about year 7. Everyone already knows this as tail risk, and it is accounted for in loss severity models. Now however, there is a disturbing trend of 2005-2007 loans being transferred to special servicing just one or two years after securitization. Goldman Sachs has projected that losses on commercial mortgages originated in 2007 could reach 11%. In fact, according to Larry Kay, director of structured finance ratings at Standard & Poor’s, 2005, 2006, 2007 vintage years comprised about 45% of all delinquencies.
However, when viewed against issuance, the rate of delinquency from recent vintages is not so alarming because they represent just a fraction of the tremendous volume generated during those years. Earlier this year, loans 60 days or more delinquent amounted to just 0.25% of 2005 volume, 0.12% in the 2006 vintage and 0.05% for 2007, according to Fitch.
“Issuance volume is a very important factor when determining which vintages may have credit issues,” said Susan Merrick, managing director at Fitch. “Certain recent vintages may have delinquent loans, but when compared to the large volume of issuance in these years, the proportion is very small.”
Where does Fitch see the most delinquencies? Loans originated in 1998 had the largest amount of delinquencies at $257.6 million, or 16.7% of all delinquent CMBS loans. That equates to a 1.43% delinquency rate for the 1998 vintage, the most of any year. The next highest delinquency rates compared with the outstanding balances in each vintage year were 2001 at 0.81%, 1997 at 0.74%, 2000 at 0.56%, and 2004, 0.49%.
That CMBS delinquencies will rise is not in dispute, only because they have been at historical lows for so long. But most of the troubles do appear to be confined to the 2005-2007 vintages, and even if the current overall default rate doubled, it would still be in line with historial averages. That is allowing some rather savvy investors to see through the hysteria and pick through the bargain bin. Some beaten up REITs are even getting into the act by repurchasing their own CDO debt.
Interestingly enough, Jassem (the State of New Jersey portfolio manager) was originally interested in allocating 1% to REITs but the recent market volatility kept her at bay. “We’re willing to miss out on the first 10% of the upside,” she said, explaining that the fund will wait until she can clearly see the REIT bottom in the rear view mirror.
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