REIT Wrecks.com

Blackrock: Back up the Truck on CMBS

noreply@blogger.com (REIT Wrecks) — Wed, 02 Jul 2008 01:44:00 +0000

Last week, traders reported volatility over CMBS and CMBX as headlines of bank downgrades and quoted predictions of summer oil at $170 a barrel influenced investor confidence. CMBX spreads widened and dollar prices dropped across all tranches of all series during the past week, according to JPMorgan research. Spread widening has continued this week amid persistent rumors of more trouble at Lehman.

However, according to Reuters, Blackrock's President, Robert Kapito, was unfazed. While he thinks that there will be a much bigger slowdown in 2009, citing slowing growth in emerging markets and tightening pressures on the U.S. consumer, he sees big value in commercial mortgage backed securities.

"We think there's going to be a global slowdown," he said at a lunch sponsored by the Securities Industry and Financial Markets Association in New York. BlackRock is the largest publicly traded U.S. asset manager with about $1.4 trillion in assets under management.

Using a baseball reference, Kapito said the credit crisis is in the fourth inning, indicating he believes the crisis is nearly halfway over.

"Inflation is up, housing is down," he said. "The consumer is hurt. I can't think of one positive thing for the consumer here."

"BEST TIME" FOR BONDS

But amid the poor economic outlook, Kapito said there are bright spots for investors.

Declines in residential and commercial mortgage-backed securities since last year have created some of the best buying opportunities for fixed-income money managers in history, he said.

"If you take a look in the marketplace, and step back from what's going on, this is the best time that we've ever been in to add value to a portfolio," he said.

Challenges remain, however, since homeowners are still defaulting on loans and house prices are falling. But money managers who have the ability to do the proper credit research can "ferret out" good opportunities, he said.

Kapito said securities backed by loans on properties such as office buildings, retail stores and hotels were especially attractive, in addition to residential mortgage bonds that do not carry the guarantees of Fannie Mae and Freddie Mac, the two government-sponsored enterprises.

"I am a big believer in backing up the truck and buying CMBS," he said, referring to commercial mortgage-backed securities.

The Repricing of Risk: Petra Peels the Onion

noreply@blogger.com (REIT Wrecks) — Mon, 30 Jun 2008 02:36:00 +0000

In Ever Increasing Numbers, Vulture Investors Are Circling Commercial Mortgages, Citing a Price/Value Disconnect, But Expect Book Values to Remain Under Pressure as More Distressed Trades Begin to Hit the Tape.

Petra Real Estate Opportunity Trust, a New York-base REIT intending to invest in commercial mortgage loans, recently filed a registration statement for an initial public offering with the U.S. Securities & Exchange Commission. Behind the REIT is Andrew Stone's Petra Capital Management, a $3.7 billion hedge fund focused on real estate debt and related financial instruments. Through its IPO, Petra is looking to raise $200 million, alongside a private 144a offering of $250 million which commenced on June 4th.

Stone began his career in 1981 at Salomon Brothers in the Mortgage-Backed Securities Department, where he became a senior trader responsible for the day-to-day management of the mortgage-backed securities trading group, which was headed by the legendary Lewis Ranieri. Stone and his team were responsible for structuring and trading the new real estate finance products that Salomon Brothers was then bringing to the market. Those products became the lifeblood of the mortgage market we now know and casually took for granted until late 2006.

After a series of senior real estate finance related positions at a number of Wall Street firms, Stone eventually landed at CSFB in 1995, where he formed the firm's Principal Transactions Group, or the PTG, which was Credit Suisse’s global real estate business. The PTG also functioned as a proprietary investment vehicle within Credit Suisse to invest in mortgage- and asset-backed and other real estate-related debt and equity. Stone was eventually forced out after management became concerned that he was literally betting the bank.

Stone then formed Petra, which had assets under management of approximately $3.7 billion as of March 31, 2008, consisting of commercial real estate finance investments of approximately $1.6 billion and approximately $418 million of equity. The Petra Fund has generated cumulative net returns since inception of approximately 23%, which ain't too shabby. Petra is named after a city in the Jordanian desert, which bible scholars believe is the place where true believers can go in order seek refuge after the arrival of the anti-christ.

With a successful hedge fund, creatively named to poke a finger in the eye of his former bosses, and a career of notable accomplishments behind him, why would Stone want to go to the trouble and hassle of organizing a lowly REIT, particularly one focused on the nuclear wasteland in mortgages? Well, it turns out that a quick look through the prospectus is both enlightening and interesting reading.

Petra's new REIT describes itself as:

"a newly organized, internally managed commercial real estate finance company formed to take advantage of inefficiencies and dislocations in the credit markets by opportunistically acquiring and originating commercial mortgage loans and other real estate-related assets that generate risk-adjusted returns that currently exceed those typically expected under normal market conditions."

These are obviously dangerous areas for investing right now, nevermind in an IPO for a newly organized commercial mortgage REIT, but Petra looks to be calling a bottom with this new offering. In the filing, Petra says it thinks that "current conditions in the credit markets have created investment opportunities of a magnitude that arise infrequently in the financial markets."

The draft S1 goes on to say that "concerns that began with the deterioration of the credit quality of sub-prime residential loans and other factors have resulted in an illiquidity contagion that has impacted the values of commercial mortgage loans and other real estate-related assets despite, in our view, the lack of a deterioration in the fundamentals of such loans and assets".

The S1 compares the current credit crunch to past market disruptions, such as the stock market crash of 1987, the S&L crisis, the Russian debt crisis, LTCM and the terrorist attacks on September 11, 2001, all of which turned out to be significant opportunities for intrepid investors.

Stone is one of them, and he is in a rush. Petra says in the filing that it believes the current opportunity will exist only for "a relatively limited time period". As he knows from experience, by the time the panic in the market catches up with underlying fundamentals, savvy opportunists like Stone will have already picked over the bargain bin.

The price/value disconnect is Petra's arbitrage, and it has never been greater in commercial mortgages. As the prospectus shows, spreads for 10-year AAA CMBS are approximately 150 basis points wider today than they were only nine months earlier, as illustrated below, even after a recent minor recovery.

Despite these unprecedented spreads, nothing has changed in commercial real estate fundamentals, which remain intact. Petra's whole investment thesis is their belief that the widening spread in the commercial real estate mortgage loan market is driven by illiquid credit markets, not by deteriorating credit fundamentals.

As they illustrate in the Petra prospectus, while yields on CMBS continue to widen, CMBS delinquency rates remain as low, or lower, than before the crisis began. The disclocation in credit quality between residential subprime and CMBS has created an Alpha that hedge fund managers can only dream about:

In addition to the low commercial mortgage delinqency rates (which I have also written about extensively), Petra points out that further evidence of strong credit fundamentals in commercial real estate mortgage loans is evident in the total number of CMBS upgrades by Fitch Ratings. As of year end 2007, the number of upgrades continues to significantly exceed the number of downgrades, with Fitch having upgraded 776 classes of U.S. CMBS during 2007, compared to 70 classes that were downgraded. This is an upgrade/downgrade ratio of 11:1.

Stone is not the only one to recognize this disparity. There are now heaps of private hedge funds beating the bushes for high net worth investors and pension funds wanting to invest in this space. North River Investment Management, for example, just launched its first commercial real estate private equity fund, North River Opportunity Partners I LP with $100 million of committed capital. The fund is but one of dozens that will also initially pursue investments in discounted pools of commercial mortgage debt and originate first mortgage and mezzanine loans on commercial real estate properties.

Echoing the Petra theme, the North River prospectus notes that "current economic pressures have led to wide-scale devaluations of assets such as commercial mortgage-backed securities. At the same time, due to capital constraints, many traditional lenders have retreated from commercial mortgage financing, even for highly credit-worthy properties," said Jonathan Kaye, co-founder of North River.

So what does this mean for all of you REITwrecks bargain hunters out there? As these new funds rush into the current liquidity vacuum, attracted by commercial mortgage yields that are dramatically mispriced relative to underlying fundamentals, valuations will remain under pressure as distressed trades start taking place in increasing numbers. The effect of these transactions on "mark to market" valuations will depress portfolio values throughout 2008 and possibly well into 2009, even though the underlying performance of the collateral will remain strong and dividends continue to get paid.

As the chart below shows, commercial banks and CMBS issuers are currently the largest holders of commercial and multifamily mortgage loans, and these holders are under increasing pressure to minimize their exposure to these asset classes. Consequently, they may often sell the loans at discounts in order to maintain their liquidity in this environment (just like a margin call), particularly the CMBS issuers who got stuck with the loans when they could no longer securitize them.

Depositing those dividends is the easy part; stomaching this roller coaster ride isn't. I don't believe it will get any easier any time soon, but the ride will eventually come to an end, and I think you will be glad you bought that ticket.

Thanks for reading.

Equity Investors Have Plenty of Capital

noreply@blogger.com (REIT Wrecks) — Thu, 26 Jun 2008 01:39:00 +0000

Although sales activity is stifled, investors' interest in commercial property acquisitions is acute

According to the latest PricewaterhouseCoopers Korpacz Real Estate Investor Survey, equity funds in the market this year are slated to raise more than $318 billion, which would be up 35% from the amount targeted by the funds in the market all of last year, the report noted, citing data from Real Capital Analytics.

"It's hard to see all of this capital because it is not moving," concluded the survey of REITs, pension funds, mortgage bankers, developers, insurers and other institutional investors and property managers.

Sales since last year's third quarter have been paralyzed by a lack of debt financing caused by credit markets dislocation and by uncertainty over how far lower property prices will move. The survey said that investment capital remains on the sidelines "waiting for signs that the worst is over."

It also noted that capital is growing increasingly concerned about how much a stalled economy may impact property fundamentals.

The $46.5 billion of commercial property sales, including hotels, closed in Q1 was down about 66% from more than $135 billion in the same period a year ago, the report noted, again citing Real Capital Analytics. Moreover, less than 50 investors have spent more than $100 million in Q1. That's down from 150 that spent $100 million or more on commercial property in the year-ago period.

Much of the capital waiting on the sidelines is from foreign buyers, who began exhibiting increased interest in U.S. property last year when they accounted for more than $50 billion in investments here, more than double their 2006 amount.

The Korpacz report also said that pension funds by and large over the past year have increased their allocation targets for real estate, but noted that many of those funds may divert a large portion of those increased allocations to foreign property markets.

Office market investors seem the most confident that pricing is already turning more in favor of buyers. "While pricing may still be tricky to figure out, it appears that this market is shifting in favor of buyers," said an office investor respondent.

The survey estimates that the average capitalization rate for central business district office properties rose 5 basis points between the fourth and first quarters to 6.68%, while the average for suburban office rose 15 bp to 7.28%.

The warehouse sector's average cap rate rose 9 bp to 6.56, while in the retail sector, the average for shopping centers rose 4 bp to 7.32%, for malls it rose 3 bp to 6.71% and for power centers it rose 4 bp to 7.17%.

The multifamily sector's average dropped 4 bp to 5.75, the only sector capitalization rate decline in the survey. The survey noted that multifamily sector investing has been buoyed by debt financing from Freddie Mac and Fannie Mae, which is "helping prices remain elevated."

Meanwhile, investors are getting skittish about the economy and how that might impact property fundamentals, which had been strong through much of the credit-markets islocation. "Fundamentals have held up relatively well, but we are starting to see rental growth decline and vacancy rates inch up, which ultimately reduces value," said another respondent to survey.

Job losses, one of the most obvious symptoms of a slowed economy, pose an immediate threat to demand for multifamily property, whose national vacancy rate grew 20 bp to 5.9% in Q1.

The report noted that multifamily is grappling with over-supply that's exacerbated by a shadow market of condominium units being added to the rental inventories in some markets.

The Korpacz survey's concern about the shadow market hurting multifamily fundamentals was cited earlier this by research firm Reis Inc. that noted Miami's rental market added 1,300 condo units in the first quarter and will add another 8,500 by the end of the year.

A slowing economy may already be impacting warehouse property fundamentals, as the Korpacz report noted that the segment's average initial-year market rent in the first quarter grew 2.94%, down 29 bp from the previous quarter's growth rate and the sector's first such quarterly decline in growth rate since Q4 2005.

As a result, survey respondents predicted that warehouse properties would appreciate an average of 50 bp this year, down from a 2.71% average appreciation predicted in the Korpacz survey a year ago. Some said warehouse values could depreciate up to 10% this year.

On the retail property side, one survey respondent lamented, "As consumers spend less money on retail goods, landlords will have a harder time pushing up rental rates and collecting percentage rent."

The 2.4% of growth in same store sales during 2007 was the sector's lowest annual growth in more than 20 years, according to Bank of Tokyo Mitsubishi. The Korpacz survey also reported that while slower sales have forced many retailers to declare bankruptcy or close some stores over the past year, concern is growing that still more will shelve expansion plans in the near-term.

Recently-built and under-construction malls will have trouble reaching strong occupancy levels, while many power centers face declining rents, the Korpacz report predicted. It added that a suspected softening in fundamentals will further weaken investor demand for class-B malls, while class-A malls remain in demand but rarely come to market.

Retail strip centers have suffered one of the largest property sector sales declines, with $3.3 billion in Q1 sales down 77% from the year ago-period. But, the Korpacz report says investor demand for these properties is keen in population growth markets such as Atlanta, where 104 strip centers were sold in Q1. That's about 2.3% of the total nationwide.

Office property fundamentals remain strong with a 9.9% national vacancy rate and 17.5 million sf of leasing activity in the first quarter, both comparable to levels reported in the same period a year ago, according to Cushman & Wakefield.

But, the Korpacz survey cited widespread concern that an ongoing economic slowdown will seriously cripple office fundamentals and investor demand in suburban and tertiary markets. The concern is particularly acute in markets that have had extensive construction, such as Phoenix, where 1.1 million sf of speculative office space was added in Q1.

Office investors are also concerned that the sector has not yet realized the full impact of the economic slowdown because it tends to lag the economy's performance. One office investor remarked, "While we do not see losses in occupancy, I do think they are coming."

CW Capital Takes B Piece on $1.4BB CMBS deal

noreply@blogger.com (REIT Wrecks) — Wed, 25 Jun 2008 00:02:00 +0000

Latest CMBS Deal Launched and Priced

CRE Direct (www.credirect.com) reported that CW Capital, the mortgage lending subsidiary of Caisse de dépôt et placement du Québec, took the entire subordinated "B" note on Bank of America's $1.3billion CMBS deal, which priced on the 19th, just one day after guidance was issued. It is only the eighth deal of the year and perhaps the last for months, and the quick pricing was thought to be a consequence of scarcity value. One wonders where AHR, JER, CHC and others were in the bidding. The transaction was obviously competitive; did CW Capital's access to Canadian bank deposits give it a funding cost advantage or did the REITs just intentionally price themselves out of this deal?

Accretive earnings would seem hard to come by, since just seven conduit deals totaling $9.4 billion have priced so far this year. By the same time last year, 29 conduits totaling $113.7 billion had priced. Because conduit shops have yet to start originating loans in any sort of volume (although Wachovia was rumored to have just recently been given the go-ahead to begin new originations), the expectation is that full-year conduit volume will be no greater than perhaps $20 billion to $25 billion.

For all of last year, in comparison, $188.6 billion of conduit deals priced. Another $41.9 billion of single-borrower or floating-rate deals priced as well, which brought last year's total CMBS volume to $230.5 billion.

The transaction, Banc of America Commercial Mortgage Inc., 2008-1, is backed by 110 mortgages with a weighted average underwritten debt-service coverage ratio of 1.34x and a loan-to-value ratio of 67.4%. Many of the loans were originated some time ago, with parts having been securitized through earlier deals. From REITwrecks's perspective, these are demonstrative of strong collateral, and it looks like a departure from the weaker underwriting of 2005/2006. This also likely had a beneficial effect on pricing.

Not surprisingly, among those is the deal's largest collateral loan, a $109.3 million piece of a $344.9 million debt package that BofA had provided for a portfolio of 27 extended-stay hotels with 3,439 rooms that were formerly owned by Apple Hospitality Five, Inc., which was acquired by Inland American Real Estate Trust in a $709 million deal last year. Hotels generally attract higher cap rates and lenders generally also require lower LTV ratios and higher debt coverage.

Despite the weakening economy, the hotels generated $47.9 million of net operating income over the past 12 months, even though they were underwritten to generate $46.1 million of NOI. Other pieces of the debt package were securitized through Merrill Lynch Mortgage Trust, 2008-C1, which priced last month, and Morgan Stanley Capital I, Inc., 2008-TOP29.

Also in the collateral pool is a $64.2 million piece of a $385 million debt package on Arundel Mills, a 1.3 million sf shopping center in Hanover, MD owned by a venture between Simon Property Group and Farallon Capital. Pieces of that debt have been securitized through Merrill Lynch Mortgage Trust, 2008-C1, and Banc of America Commercial Mortgage Trust, 2007-5.

The deal also includes a $97.5 million interest-only loan on 550 West Jackson Ave., a 401,651 sf office building in Chicago owned by a group led by Mark Karasick. The property had been encumbered by $116.5 million of financing that RBS Greenwich Capital had provided and was said to be shopping when the property came under pressure as a result of the departure of a major tenant, commodities broker Refco, Inc.

Karasick had purchased the property for $125 million in 2005 before Refco's disclosure of financial improprieties. The company filed for bankruptcy protection and ultimately was acquired by Man Financial. It gave up its space at 550 West Jackson, but much of it was ultimately leased to Calyon, which already had occupied space there.

The bulk of the deal's collateral loans, representing 41.6% of its balance, were assumed by BofA through its acquisition of LaSalle Bank, while 3.4% of the deal's loans were originated by Countrywide Commercial Real Estate Finance, whose parent BofA is in the process of acquiring. Barclays originated 15.3% of the deal's loans, by balance.

The deal's junior-AAA bond class has a subordination level of 13.75%. That compares with an average of 13.5% for the seven conduit deals that have priced so far this year, but is lower than the 14.75% for the JPMorgan Chase Commercial Mortgage Trust, 2008-C2 transaction, which priced at the end of April.

Meanwhile, CMBS conduit spreads have continued to widen. Spreads on super-senior AAA bonds had tightened steadily since reaching their all-time wides in mid-March, but reversed course three weeks ago. They ended last week at an average of 156.5 basis points over swaps, according to the Commercial Real Estate Direct CMBS Pricing Matrix. The widening is the result of overall softer conditions in the broader credit markets.

Thanks again to Commercial Real Estate Direct for the bulk of this story.

Disclosure: Long AHR

Concerns Grow on CMBS Price Manipulation

noreply@blogger.com (REIT Wrecks) — Tue, 24 Jun 2008 04:05:00 +0000

AS EVIDENCE GROWS THAT THE SELLOFF WAS OVERDONE, OPPORTUNITIES TO INVEST WILL FADE. BE GREEDY NOW WHILE OTHERS ARE FEARFUL.

In early April, I reported that the Commercial Mortgage Backed Securities Association had written to the Markit Group Ltd., the London-based administrator of the CMBX Index, a synthetic credit default swap derivatives index introduced in March 2006, requesting that trading data on the index, including total volume and number of daily trades, be made publicly available in order to "increase market transparency".

The move was a clear swipe at the Markit Group and the extent to which its CMBX synthetic credit default swap had come to dominate the cash market for commercial mortgage backed securities, and by extension had also become the playground of various hedge funds attempting to execute self-fulfilling niche short trades in the same market.

As Bloomberg subsequently reported when it picked up the story, rather than dispersing risk and lowering borrowing costs as former Federal Reserve Chairman Alan Greenspan predicted, the contracts have exacerbated the debt crisis. What was intended as a way for lenders to protect against defaults spawned a market where no one knows how much is traded and speculators who bet on deteriorating credit quality can end up forcing that reality.

When the cash markets froze in late 2007 and early 2008, the indices became the only way for firms to value their portfolios in accordance with mark to market accounting requirements. Hedge funds quickly recognized the opportunity to profit by driving pricing of the CMBX indices higher, thereby forcing firms to mark down the value of the underlying cash instruments by a similar amount. Consequently, some credit-default indexes morphed into what Wachovia Corp. analyst Glenn Schultz called "Frankenstein's monster" because they now often drive prices in the so-called cash bond market, rather than the other way around.

All of this continues to have a dramatic effect on portfolio valuations for those firms subject to mark to market accounting, and possibly even played a role in the downfall of Bear Stearns. "The indices are just trading on their own account, with no relationship whatsoever to an underlying cash market," said Jacques Aigrain, chief executive officer of Zurich-based Swiss Reinsurance Co.

Fearing a repeat of losses and continued possible manipulation of their books, banks are refusing to support new indexes that would allow investors to wager on everything from auto loans to European mortgages, reining in a market that's about doubled in size every year for the past decade.

"The last thing the securitization market needs is another no-cash-upfront instrument that people can use to knock the markets about with," said Andrew Dennis, the London-based head of the asset-backed debt syndication group for UBS AG of Zurich.

Indeed, Wachovia wrote down $600 million of commercial mortgages early this year because of declines in prices indicated by CMBX indexes, and Citigroup Inc., the largest U.S. bank by assets, wrote down its subprime holdings by $18.1 billion after using ABX credit-default swap indexes to help value the assets.

However, as the latest CMBS default figures from Fitch and others indicate, commercial real estate assets themselves continue to perform well and the commercial mortgages underlying the assets have therefore suffered very little deteriotation in quality.

"TOTALLY UNCORRELATED"

While the ABX Index was the best known offender, pricing in an underlying loss rate that was at least four times that expected by some analysts, the CMBX wasn't much better. According to Bloomberg, the cost to protect $10 million of AAA commercial mortgage securities jumped 10-fold during one six-month period to $100,000 a year, based on the first CMBX index from Markit. That implies about 13 percent losses on the underlying loans, also more than four times the worst case 2.8 percent loss rate forecast by JPMorgan analyst Alan Todd.

"The ABX, CMBX, any kind of X you like, are totally uncorrelated to any kind of underlying market," Swiss Re's Aigrain said.

This is has all led to a great deal of controversy over the merits of mark to market accounting. Even Helicopter Ben saw fit to weigh in on the issue when asked about it recently in a question and answer session. According to Reuters, Bernanke said that on balance mark-to-market has worked well, but "it's also true in the current context, that mark-to-market accounting has been sometimes destabilizing in that sales of assets into very illiquid markets had led to reductions in prices, which have caused writedowns which have sometimes caused firesales, and you get into an adverse dynamic which has caused problems in some of our markets,"

While he said mark-to-market accounting has been a positive influence for investors, he also said that valuations should be determined during normally functioning, stable markets, not times when assets are illiquid.

It's a controversial topic, but any changes to mark to market accounting would be unfortunate and detrimental. This latest market dislocation is simply the result of the latest incarnation of the investment bubble, and protecting investors from the market's healthy aftermath would only encourage even more "irrational exuberance".

More importantly, it would penalize those investors who had the patience and foresight to avoid the bubble in the first place. For those fortunate few, the opportunities that now exist in the REITwrecks world have created one one of the best environments in history for investing in Mortgage REITs.

Multifamily Mortgage Market Stable & Growing

noreply@blogger.com (REIT Wrecks) — Fri, 20 Jun 2008 22:24:00 +0000

Delinquencies Remain Low in the Multifamily Sector; Level of Outstanding Debt Grew in the First Quarter

At least one corner of the mortgage market remains healthy: multifamily mortgages, which is good news for those mortgage REITs diversified among the four commerical real estate "food" groups. It is also a huge market, and one that is vitally important to our economy for a number of reasons, so good numbers are just that, good.

Most importantly, The Mortgage Bankers Association says that delinquency rates on commercial/multifamily mortgages remain low - up slightly from the fourth quarter of 2007 but still finishing the first quarter of 2008 near record lows.

These numbers come from figures reported by five of the largest investor-groups: commercial banks and thrifts, commercial mortgage-backed securities (CMBS), life insurance companies, Fannie Mae and Freddie Mac. Together these groups hold more than 80 percent of commercial/multifamily mortgage debt outstanding.

"In contrast to mortgages for single-family residential properties, commercial/multifamily mortgages continue to perform very well," said Jamie Woodwell, MBA's Senior Director of Commercial/Multifamily Research. "Most investor groups saw delinquency rates rise slightly in the first quarter, but they remain at the low end of their historical range."

The 30+ day delinquency rate on loans held in CMBS transactions rose less than one tenth of one percent (to 0.48 percent), while the 60+ day delinquency rate on loans held in life company portfolios remained flat at an incredibly low 0.01 percent. The delinquency rate on multifamily loans held or insured by Fannie Mae and Freddie remain under 1%, while the 90+day delinquency rate on loans held by FDIC-insured banks and thrifts rose 0.21 percentage points to 1.01 percent.

The delinquency figures also illustrate the success of the low leverage model employed by the life insurance companies - they typically underwrite loans with using lower LTV ratios and much better debt coverage. That was a difficult business model in the credit bubble, and their portfolios barely grew, but they stuck to their knitting and widows and orphans cashing those annuity checks can continue to sleep at night: of the 35,192 commercial/multifamily loans in life company portfolios, only 10 loans were 60+ days delinquent at the end of the quarter. These 10 loans had an aggregate unpaid principal balance of just $29 million, a virtual rain drop in the Pacific Ocean in comparison to the over $300 billion in multi-family loans held by insurance companies.

Based on the unpaid principal balance of loans, delinquency rates for each group at the end of the fourth quarter were as follows:

• CMBS: 0.48 percent (30+ days delinquent or in REO);
• Life company portfolios: 0.01 percent (60+days delinquent);
• Fannie Mae: 0.09 percent (60 or more days delinquent)
• Freddie Mac: 0.04 percent (60 or more days delinquent);
• Banks and thrifts: 1.01 percent (90+ days delinquent or in non-accrual).

Meanwhile, despite the contraction in the overall CMBS market, and almost every other credit market including, astonishingly enough, even the municipal bond market, the total level of commercial/multifamily mortgage debt outstanding managed to grow by 1.8 percent in the first quarter, to $3.4 trillion, according to Federal Reserve Board Flow of Funds data.

The $3.4 trillion in commercial/multifamily mortgage debt outstanding recorded by the Federal Reserve was an increase of $60.8 billion from the fourth quarter 2007. Multifamily mortgage debt outstanding grew to $856 billion, an increase of $18.5 billion or 2.2 percent from the fourth quarter.

"Investors continue to increase their holdings of commercial/multifamily mortgages," said the MBA's Woodwell. "The global credit crunch meant a net decline in the balance of mortgages held in CMBS, CDO and other ABS, but banks, thrifts, life insurance companies, Fannie Mae, Freddie Mac and nearly every other investor group increased their holdings of commercial and multifamily mortgages during the quarter."

The Federal Reserve's Flow of Funds data indicate that commercial banks continue to hold the largest share of commercial/multifamily mortgages, $1.43 trillion, or 42 percent of the "total", but many of these loans are actually corporate loans in which a piece of commercial property has been pledged as collateral. However, because the other loans reported are generally income property loans, meaning that the debt service comes only from rent payments, the commercial bank numbers are not strictly comparable.

Thus, the CMBS, CDO and other ABS issues are the largest holders of "pure" income producing commercial/multifamily mortgages, with $777 billion outstanding, according the the Fed (everybody reports this number differently, but it is a huge market no matter how it's measured). Life insurance companies hold $309 billion, and savings institutions hold $226 billion.

Government Sponsored Enterprises (GSEs) and GSE-backed mortgage pools, including Fannie Mae, Freddie Mac and Ginnie Mae, hold the largest share of multifamily mortgages, with $143 billion in securitized multifamily loans and an additional $158 billion "whole" loans in their own portfolios, or 35% of the total. (N.B., for you number fact freaks - I am one - many life insurance companies, banks and the GSEs also purchase and hold a large number of CMBS, CDO and other ABS issues. These loans are covered in the CMBS, CDO and other ABS category.)

MULTIFAMILY MORTGAGE DEBT OUTSTANDING

In this "new" credit environment, The GSEs (Fannie Mae, Freddie Mac, etc.,) and Ginnie Mae are now an even bigger factor in supporting our nation's housing stock. Not only do they hold the largest share of multi-family debt outstanding, but Fannie Mae is now almost the only game in town when it comes to financing multi-family property. Fannie Mae is there, and I can tell you they are writing checks.

This has been incredibly important in relieving at least some pressure on the demand for new commercial real estate credit, and probably for reducing overall default rates in CMBS pools, which still remain at historic lows. As I wrote in another post, High Yield Mortgage REITs, the Perfect Storm?, the low levels of CMBS debt scheduled to mature in 2008/2009 is also a big factor. Combined, these two supply inputs undoubtedly contributed to that fact that, according to Fitch Ratings, 99% of all maturing CMBS loans since August 2007 have been successfully refinanced.

Consequently, GSE's share of multi-family debt will only increase in the coming quarters, since credit officers at commercial banks, which hold $173 billion, or 20 percent of total outstanding multi-family debt, are spending more time calculating portfolio write downs than assessing new risk. And of course, the CMBS, CDO and ABS markets, which had been approaching $250 billion a year in new origination volume, now look unlikey to match even half that in 2008.

Indeed, of $18 billion increase in multifamily mortgage debt outstanding between the fourth quarter 2007 and first quarter 2008, Government Sponsored Enterprises underwrote $10 billion, or 54 percent of the total increase. Agency and GSE-backed mortgage pools increased their holdings by $3.4 billion and commercial banks increased their holdings by $4 billion. Nobody would be surprised to learn that the CMBS, CDO and ABS categories saw the biggest drop in their holdings of multifamily mortgage debt: a decrease of $9 billion.

In spite of the implosion in the CMBS,CDO and ABS markets, these figures show that at least one segment of the commercial real estate mortgage market is holding up well, possibly even thriving, and they are demonstrative of one of the underlying, basic truths of commercial real estate: Assets that produce reliably monthly income will survive, and so will the mortgages that support them.

Disclosure: None

The Trouble With TruPs

noreply@blogger.com (REIT Wrecks) — Wed, 18 Jun 2008 18:52:00 +0000

After looking at some potential apartment acquisitions in Ohio last week, American Airlines flew me back home through the lively metropolis of St. Louis. During the layover, I had a chance to read the St. Louis Business Journal, which featured on its front page a story about bad loans and their effect on local banks. It was entitled "Bad Loans Intensify Bank's Pain." Lively indeed!

First Bank, a firm headquartered in St. Louis, sounds like a real basket case: loan charge offs in the latest quarter were up 202% and profits were down 90%, to just $2.5 million from $25 million a year earlier. Its parent, First Banks, Inc., also disclosed that profits were overstated by $11.1 million over three years due to irregularities in its mortgage division.

Non-peforming loans were so common that 25 banks chartered in the region and surveyed by the Business Times reported that cumulative increases in NPLs were up 165% vs the year prior and profits were down more than 35%.

According the the Business Times, bankers there expect it to get worse before it gets better. "I expect the first quarter trend showing greater charge offs to continue through most of 2008", said Mike Flavin, President if the Business Bank of St. Louis.

Falling home prices remain at the center of the problem as these regional banks, which were basically forced out of big real estate and corporate loan syndicates by the ravenous and much cheaper CDO, CLO and CMBS markets, wound up heavily exposed to local housing markets with risky loans to small, local developers.

Not only have these banks been getting burned by loans to developers, but high yielding small loans to rehabbers have also turned south. "The rehabbing business has been difficult," said Rick Bagy, President of the First National Bank of St. Louis. "Everyone went into the rehab business in the last 10 years - doctors, lawyers, housewives - because it was easy money."

And punctuating that point was still another article relating the story of Triad Bank, yet another local lender, that was foreclosing on a local rehabber and seeking up to $1 million in the foreclosure suit. These are big numbers for small local banks and one of the major reasons why the FDIC, OCC and other regulators are stepping up their supervision of local and regional banks and their lending practices.

Forget worrying only about commercial mortgages, there are a number of Mortgage REITs out there, as many of you know, that bought and originated Trust Preferred's as a way of diversifying out of real estate. Many of these TruPs were covenant-lite and therefore poster children of the credit bubble: easy money just didn't get any easier. This was because these particular REITs were turning around and issuing CDOs secured by the TruPs, which was the ultimate OPM game. For those of you who don't know what OPM is, there is a book entitled OPM that was written about a leasing company of the same name. It is great reading, and illustrative of what happens when a lender's interests and a borrower's interests are no longer aligned.

No earnings after issuance? No problem! Busted tangible net worth covenants? Why bother to calculate it, pay that mob of lawyers to get it right in the docs and then monitor it all for compliance? Let's just leave that pesky provision out of the deal, shall we? After all, it's not our money, hey? We're just in it to collect management fees, so it's really no problem if you don't pay us back.

Among the many concerns now facing the banks that coughed up TruPs as fast as the lawyers could replace the ink cartridges on their printers are strong recessionary pressures within the US economy, outsized exposure to residential construction loans and home equity loans, and reduced short-term profitability. Significantly, these are not isolated problems at one or two thrifts, or just one or two wayward mortgage lenders (e.g., IMB). It is spread throughout the country, and it is particularly bad in the Southeast and West, two of the hottest housing markets in 2005 and 2006.

Fitch Ratings, evidencing this increasing pressure, has been notified of the deferral of TruPs payments at 11 banks and the complete default of one since September 2007. These 12 banks issued US$644.5m in aggregate TruPs and subordinated debt through 46 Fitch-rated CDOs. "Further bank deferral and default activity is likely, given current economic conditions," says Fitch senior director Nathan Flanders.

Near-term wholesale defaults appear unlikely, but the breadth of the problem is the issue, as evidenced by my anecdotal reading of just one midwestern business journal on my way through an airport. I'm not sure that anyone could have seen it all coming, except that the lack of covenants should have been a tip off: without covenants, there is no way to declare a technical default and get access to assets before it's too late.

As a result of the observed and expected collateral deterioration underlying bank TruPs, Fitch has revised both its rating and asset performance outlook on US bank TruPs CDOs from stable to negative. This should be no wonder, since by the time they are able to declare a monetary default, holders of the TruPs will be practically last in line for any recovery.

Fitch is also currently reviewing bank TruPs CDOs with deferral and/or default exposure or other high-risk exposure and expects to place materially affected transactions on rating watch negative in the near future. "The magnitude of underlying collateral currently in deferral or default will likely be the most significant determining factor in Fitch's analysis," adds Flanders.

Not wanting to get caught with its blinders on, Fitch says that its deliberations on ratings will also give consideration to individual exposures that Fitch believes will create increased risk, such as banks facing heightened regulatory scrutiny, banks which have recently reduced or eliminated dividends on common equity, or those with an above average level of exposure to high risk real estate. Given what's been happening in the market, this would seem to include just about everybody.

Additionally, Moody's has downgraded 53 tranches issued by 10 CDOs with significant exposure to residential mortgage REIT Trust Preferred Securities (Trups) and homebuilder securities. It said that the rating actions were prompted by continued credit deterioration and defaults in the residential mortgage REIT and homebuilder sectors.

Four of the affected CDO series include Attentus CDO (series I to III), Kodiak CDO (series I), Taberna Preferred Funding (series II to VII) and Trapeza CDO (series X). Moody's said that these CDOs have significant exposure to these sectors, ranging from approximately 25% to 50% of their aggregate portfolio balances. The rating actions also reflect uncertainties over final workout values, which are expected to be low (hence my rant on covenants before).

Not surprisingly, Moody's outlook for REIT TruP CDOs is also negative for 2008. The Taberna series were essentially issued by RAS, since it made its ill-fated purchase of Taberna and is now stuck with the mess. I don't mean to imply that a few isolated downgrades of these CDOs will be a huge problem for REITs like RAS. However, taken cumulatively with other problems, these downgrades - and the trouble they signify for the underlying TruPs collateral - could be the tipping point for those in the REIT menagerie that are struggling with a whole smorgasbord of other problems. These would include forced liquidations of assets, subsequent trouble satisfying IRS REIT income requirements and general head scratching in the board room when it comes to declaring dividends after all the defaulted scrip has been siezed or sold off.

Always looking for ways to have fun in this abysmal market, I have actually written about one such REIT in this very article. Long time readers may have noticed that having fun has not included kicking those that are down and out, but this is too important, as there is real money to be made with the survivors. Some of the more troubled REITs may also survive, but probably not as REITs, and definitely not with those head scratching dividends.

For a clue, look no further than the first letter of each paragraph.

Nuff said!

Disclosure: None

Update: Please take a look at the WSJ article which appeared today (Wednesday, June 25th) entitled "Small Banks Face a Looming Hit From Builders' Interest-Reserve Loans". The article contends that small banks are more heavily exposed to construction & development loans than bigger superregional and money center banks, and that the FDIC and OCC are examining in loans in asset-level detail to determine their performance status.

Apparently, some of these banks are using the interest reserve escrow accounts to maintain "current" status on loans secured by assets that are anything but. The article says that banking analysts worry that 150 small banks could fail in the next "few years" because of big bets on these construction loans. The FDIC has issued "cease and desist" orders to banks ranging from National City (subject of another, earlier WSJ article) to HomeTown Bank of Villa Rica, GA.

Please don't bet the "ranch" on AFN; it seems that many of their TruPs obligors may have already done so.

Mark to Market Losses Starting to Reverse?

noreply@blogger.com (REIT Wrecks) — Tue, 17 Jun 2008 22:31:00 +0000

In the first quarter of 2007, subprime mortgages provided the first sign of trouble in the credit markets as falling housing prices began to hit borrowers hard. But in the first quarter of 2008, home-equity lines of credit became the new canary in the coal mine. Lenders such as National City have frozen existing home equity lines of credit, and as housing troubles show no signs of abating, these commercial banks are rushing for the HELOC exits with hedge fund-like alacrity.

Indeed, as real wages continue to fall with the recent increase in oil and food prices, the gap between home prices and median income continues to be way out of whack - despite the continuing decline in home prices. Folks, the bottom in housing is simply nowhere in sight.

Amplifying the point was Financial Security Assurance Ltd., which last month said that loss projections for these home equity loans rose in the first quarter. Embattled FSA increased its loss estimate by $355 million in the first quarter, as losses were particularly high in eight of its insured securities backed by home-equity lines of credit.

As everyone knows, these loans consist of lines of credit secured by home equity, which has been disappearing faster than high paying jobs on Wall Street. So far, FSA has paid $104.2 million in net claims on the transactions. Robert P. Cochran, chairman and chief executive of FSA, said that "since the beginning of 2008, these transactions have experienced much higher default rates than ever observed in the past."

Moody's then corroborated FSAs public trouble with a news release of its own, disclosing that losses in some of its insured home equity loan transactions had also risen rapidly. Moody's Investors Services boosted its average loss expectations for securities backed by subprime second mortgages to 17% for 2005 vintage subprime pools, 42% for 2006 vintage pools, and to 45% for 2007 loan pools.

As I wrote earlier, these delinquency figures broken out by vintage illustrate the absolute imperative of investing in Mortgage REITs that have been around the block a few times. Those REITs that started up in the halcyon days of 2005 and 2006 simply have a huge hurdle to overcome: portfolios that are now stuffed full of weak, demand-driven paper. Their workout teams had better be good and well rested, because it looks like they will be busy into the next decade.

Indeed, Ambac cited one transaction where it said delinquencies topped 81% of loans. Significantly, both Ambac and MBIA said they were looking into some loans to see if they lived up to the standards of the securitization agreements. Since many of the underlying loans in question were originated by Countrywide Financial Corp (CFC), one must wonder how carefully Bank of America (BAC) read the investor put provisions in these deals before agreeing to purchase the Company.

Luckily for FSA, it avoided one of the most risky areas of the CMBS market: writing credit default swaps on CDOs backed by all these imploding mortgage loans. However, FSA did write credit default swaps on corporate risk and took a negative market value adjustment of $317.9 million in the first quarter.

In my two earlier articles on mark to market accounting, Mr Market Trips on Mark to Market and the more detailed follow-up How Markit Turned Mr. Market into Mr. Magoo, I emphasized that unlike realized losses, these market value losses only reflect decreases in the market value of the securities in question, not actual cash losses. Consequently, those losses have the potential to reverse if the market moves in the other direction. Thus, in FSA's case, their $317.9 million negative mark could potentially be erased, or even become a future gain, if credit spreads tighten.

And here is the story within the story: according to FSA CEO Cochran, that has already begun happening. Credit spreads have "tightened significantly since the end of the quarter," which would mean that FSA could end up recording a positive market value adjustment on its balance sheet in the second quarter. "It is hard to give a number where we stand now, but no doubt it would be positive," Cochran said.

As the CMBX and ABX continue to tighten, and LIBOR and TED spreads get back to normal, positive market value adjustments (which would be reported as non-cash gains) will become more common. This will be particularly true for seasoned mortgage REITs that stuck to their knitting and resisted temptation with disciplined credit standards. Combined with the additional clarity arising from the adoption of FAS 159, book values will start looking a little more appetizing in the next few quarters.

Good news does not sell nearly as well as bad news, so I guess the traditional news outlets don't focus on it as much. It sure is fun to write about it though, and it's just as important as the opposite truths we've been hearing so much about. REIT Wrecks has your back!

CMBS Prices Reflect Irrational Fears

noreply@blogger.com (REIT Wrecks) — Tue, 10 Jun 2008 02:06:00 +0000

"MARKET FEARS AND THE LIQUIDITY CRUNCH HAVE DRAMATICALLY DISTORTED THE VALUE OF CMBS, CREATING ONE OF THE BEST ENVIRONMENTS IN HISTORY FOR INVESTING IN CMBS."

The Commercial Mortgage Securities Association (CMSA) yesterday presented new data on the pricing of commercial mortgage-backed securities (CMBS) compared to their fair value and returns relative to risk profile. The study predicts CMBS will perform well in a deteriorating recessionary environment.

It concluded that current spreads for most CMBS vintages are still far wider than their fair value, an irrational market reaction that presents significant arbitrage opportunities for investors."There are no skeletons in the CMBS closet," said Jun Han, Ph. D., the author of the study.

The study performed multiple stress tests on CMBS bonds based on three historical and worst-case recession scenarios. It analyzed all 19,583 commercial mortgage loans in the 675 CMBS bonds that make up the four CMBX indices, which account for approximately 39% of fixed rate conduit CMBS outstanding.

The study concludes that investors have strong reasons to be optimistic. Among the findings revealed were:

Fixed-rate, investment-grade CMBS perform very well in the study's stress-tested analysis, with minimal defaults, credit losses or yield degradation. No CMBS rated AA or higher are expected to incur any loss under the study's recession scenario, while 99% of A-rated CMBS should be free of losses and the remaining 1% should incur only a small loss.

The risk of CMBS downgrades is very limited. For example, 98% of AAA-rated CMBS and 94% of A-rated CMBS are at no risk of downgrade in a recession scenario.

Current CMBX index spreads unreasonably imply a "doomsday scenario," with such spreads implying that future defaults and losses would be many times the levels of historical experience. Incredibly, when applying the spreads at which the CMBX 4 index has recently traded, the implied annual collateral default rate was over 100% for AAA-rated CMBS on March 20, compared to a historical CMBS average of less than 1%.

"Just how off-target is the CMBX market? We can actually put a dollar value on it," Dr. Han comments. "When applying a worst case 1986 stress test scenario, spreads on the CMBX 4 index of almost 1,200 basis points over T-bills, were almost twice as high as would have been expected at fair value."

"This demonstrates the kinds of distortions and limitations of ceding the determination of value of the nearly $1 trillion CMBS market to an untested and volatile derivatives index during an unprecedented credit and liquidity crisis."

PIMCO Still Piling into Mortgages

noreply@blogger.com (REIT Wrecks) — Sat, 24 May 2008 18:19:00 +0000

In April I posted Bloomberg's report that had PIMCO more than doubled the mortgage holdings in its flagship Total Return Fund from 23% of assets in March of last year to almost 50% of assets in March of 2008.

Now the FT is reporting that PIMCO has continued to build its position. Bill Gross, the manager of the world's biggest bond fund, has now almost tripled his mortgage debt holdings to more than 60% of the fund.

According to the FT, the Total Return Fund fund pulled sharply ahead of rivals in the past year after Gross predicted a housing downturn and sold out of housing-related securities and corporate bonds. The fund has returned 12.6% over 12 months, beating 99% of its peers, according to fund tracker Morningstar.

Mr Gross said his decision to raise exposure to mortgage debt in recent months was based on the US government's implicit guarantee of Freddie Mac and Fannie Mae, the government-sponsored mortgage agencies. "Government policy is moving to sanctify the status of the government-sponsored agencies . . . it became a question of which institutions would be sheltered by the government umbrella," he said.

So far, the bet appears to be paying off. In the first four months of this year, the fund returned 3.8%, twice the return of its benchmark index and its best start to the year in at least eight years. Mr Gross said Pimco was buying primarily mortgage agency debt and "not the subprime garbage". The Total Return fund is now invested about 61% in mortgage debt. Such debt comprises only 43% of one of the fund's benchmarks, the Lehman Aggregate bond index.

Mr Gross, who is also Pimco's co-chief investment officer, is known for his macro-economic style of investing, which has seen him take big bets on bond classes depending on where he thinks financial markets might be moving. Mr Gross was heavily overweight US Treasury bonds in the early 2000s but is now scornful of them and the fund is using derivatives to gain from any downturn in Treasuries.

He called Treasuries "the most overvalued asset". "If there was a bubble, the popping has produced a counter-bubble in quality securities. The safe haven has been way overdone. Treasuries are yielding 2 to 3%, there is no real return on that at all," he said. "This is an asset class that is held by sovereign wealth funds and central banks . . . but that is not any reason to follow them."

There may be no reason to follow the herd into Treasuries, but apparently there is still plenty of reason to take a closer look at the disconnect between price and value in Mortgage REITs.

Powered By GE, SFI Sinks Three Pointer on Fremont Debt

noreply@blogger.com (REIT Wrecks) — Thu, 15 May 2008 23:28:00 +0000

SFI To Use Net Proceeds of $960 Million Financing to Repay Existing Debt

Costar reported today that GE Real Estate's New York regional office completed a $960million interest-only first mortgage financing with iStar Financial Inc., secured by 34 single-tenant office, R&D and industrial properties in 12 states.

According to Costar, this financing for iStar represents the largest debt deal of 2008 for GE Real Estate. It is also the largest loan originated by the company in the past several years. Funding of approximately $810 million occurred at the initial closing of the financing. The balance of the funds is expected to be provided before the end of the second quarter of 2008, subject to the finalization of additional loan documentation. The three-year financing is pre-payable in 20 months.

The Boston and New York offices of HFF (Holliday Fenoglio Fowler LP) arranged the loan on behalf of iStar and which closed in less than 45 days.

"While sizeable, this is a relatively conservative transaction, well-margined and secured by a geographically-diverse portfolio of single-tenant properties. Almost half the tenants are rated investment grade," said Alec Burger, president of GE Real Estate's North America Lending division. "We've known the management of iStar for several years and are confident they will use this financing to build a strong platform for the future. We see this as the first of many deals together."

HFF directors Janet Krolman and Greg LaBine and executive managing director John Fowler (New York) worked exclusively on behalf to secure the adjustable-rate, interest only, cross-collateralized and cross-defaulted loan.

"Historically, iStar would have obtained financing on an unsecured basis by utilizing the company's BBB, investment grade credit rating. However, the current market conditions are such that it was more efficient and cost effective to finance a subset of their existing single tenant portfolio on a secured basis," said Krolman.

"There were a number of ways to accomplish this including putting together a club deal to finance the portfolio, splitting the portfolio into smaller sub-portfolios or financing the whole portfolio with one source," LaBine added. "iStar concluded that a one-stop-shop alternative with GE was the best fit for their needs, as it was a simpler, cost-effective alternative that was accomplished in a very short time frame," Fowler said.

The portfolio of properties totals nearly 12 million square feet and is currently 99.6% occupied with an average lease term of 9.2 years. Nearly half of the approximately 21.9 million-square-foot portfolio is leased to tenants that are rated investment grade.

Costar reported that iStar will use the net proceeds of the three-year floating rate, cross-collateralized and cross-defaulted loan to retire existing debt, which presumably means the $1.3 billion Fremont acquisition loan due June 30.

With this new deal, SFI takes a significant step forward in the serpentine process of swallowing Fremont's commercial loan business. It's just one more fascinating story playing out in the REITwrecks world.

Good News for High Yield Mortgage REITs: Commercial RE Debt Markets Are Stabilizing

noreply@blogger.com (REIT Wrecks) — Wed, 14 May 2008 15:11:00 +0000

Is the Credit Crunch Over? Maybe, But Opportunities Still Abound in the REITwrecks World.

REITwrecks is back! And with good news. Not only is the Indian Ocean still a great place to recreate, but according to indications in the CMBS and CMBX markets, and recent reports by all three of the major ratings agencies, there are increasing signs that the commercial real estate debt markets are stabilizing. As REITwrecks reported earlier, and rather emphatically, the CMBX and CMBS cash markets were just completely divorced from commercial RE fundamentals (and several astute readers posted comments consistent with this price vs. value disconnect).

Back then, seemingly a hundred years ago, there was no need for a ticket to Vegas: if you were an investor in this sector, all the adrenaline your heart desired could be had sitting right in front of your computer.

Indeed, when nobody was looking and the kids were safely tucked in bed, you could have picked up RAS at $6.75, NRF at $8 and AHR and $6.50. But as everybody knows, it was no time for the faint of heart, and REITwrecks lost a lot of donuts employing this price/value thesis on the likes of SFI and NCT.

But that was then and this is now. Despite widening in both the CMBS cash market and the CMBX last week, the market seems increasingly optimistic that the worst is behind it, and some established players are suggesting that the wild swings in volatility seen since September of 2007 are almost gone for good.

"The yet-to-be-finished de-leveraging process is still likely to exert technical pressure in the market, and volatility could persist for a while as was evident in (CMBX) widening," Citigroup researchers said in their Bond Market Roundup. "But it appears that the market should now be fairly close to fully redirecting attention to the actual and projected performance of the underlying collateral, as this performance, rather than technical forces, should determine bond value going forward."

Recent successful executions of new issue bonds by Lehman Brothers/UBS and JPMorgan/CIBC are also pointed to as examples that the market is returning to something more similar to its former self.

"People say they are comfortable with the fact that CMBS is not connected to residential subprime," one dealer said. "This hadn't been the case until recently."

Indeed, although delinquencies on residential mortgage loans continue to skyrocket, that’s not occurring among U.S. CMBS. Securities backed by commercial real estate loans have deteriorated only modestly. The Fitch Ratings’ CMBS delinquency index rose by three basis points, to 0.33%, in March, the second monthly increase in a row, but still low by historical standards.

“At this point, there is not cause for alarm,” Susan Merrick, managing director and CMBS group head, said in an interview. Although the delinquency rate is expected to rise to about 1% over the course of this year, Ms. Merrick said it will still be “just a bit above the historic average.”

Meanwhile, as the CMBS market sorts itself out and mark-to-market accounting fades from the headlines, borrowers are finding capital elsewhere. According to a new report by S&P, borrowers continue to find parties willing to refinance their CMBS loans, despite reduced liquidity for real estate funding and tighter lending standards.

"Debt financing for commercial real estate is available - albeit at a higher cost - from balance sheet lenders and other market participants, who see a window of opportunity for achieving attractive pricing even on conservatively underwritten loans," the report read.

The report noted that two of the three floating-rate loans with final maturities in the first quarter were refinanced and fully paid off. The third, the highly publized and much-worrisome Macklowe/EOP loan included in the COMM 2007 FL14 transaction did not pay off at its schedule final maturity. However, S&P suggested that the full retirement of the Macklowe COMM 2007-FL14 debt did take place on April 14. S&P said it viewed the Macklowe deal as highly positive given the transaction's size, complex debt structure and the number of parties with varying economic interests.

Fitch also noted an uptick in loans underlying the CMBS that are not refinancing precisely at their maturity date, thus putting them in non-performing status. The number of loans in this category increased to 11.6% of the Fitch delinquency index in March, compared with 2.9% a year ago.

However, Fitch noted that the majority of the fixed-rate "non-performing" matured loans have paid off in full or extended their terms within 60 days of being transferred to delinquent status, avoiding full default. For example, of the 26 fixed-rate, non-performing matured loans still outstanding at the end of January, only eight loans, comprising $26.2 million, had not refinanced by the end of March.

“Certainly there’s a lot less capital in the markets, but the loans that have matured so far have refinanced” when necessary, with capital being provided either by regional banks or insurance companies, Ms. Merrick said.

All this could be good news for the refinancing of IStar's Fremont acquisition debt, and it may be why SFI's stock has been on such a tear recently. SFI's $1.3 bridge loan is due June 30th, and the Company is now almost certainly neck deep in negotiations with the banks who led the deal (JPMorgan Chase, Citi and Bank of America). As mentioned earlier, REITwrecks had an early long position in SFI that wound up in a sea of red (I much prefer the warmth of the Indian Ocean), but now that 30 days have passed and the wash-sale rule is no longer in effect, it may time to reestablish that position. As I wrote before, the Mortgage REIT madness was the perfect storm, and some of the opportunities it has created are still compelling for those with patient, discerning money.

As for the CMBS calendar, only two new deals are thought to be in the works, one from Merrill Lynch which may come in the next couple of weeks, and one from Banc of America which may come sometime in May or June, according to Citigroup research.

In addition to S&P, Moody's Investors Service has also been hard at work. In their just released review of US CMBS for the first quarter of 2008, Moody's says the final tally for traditional conduit issuance for the year could be less than $35 billion, but like S&P and Fitch, they expect balance-sheet-driven transactions by financial institutions to take up some of the slack. It is a vast change from last year's record US CMBS issuance of $230 billion.

Nick Levidy, Moody's Managing Director, expects the sector to take "several years to re-group". In retrospect, "perhaps US CMBS should be viewed as a $50 billion to $100 billion per year business that spiked to $200 billion during a credit bubble rather than a $200 billion business having an off year," Levidy adds.

This is probably true, given the multiplier effect that the now defunct SIVs, CDOs and commercial paper conduits had on the market, and it is yet another reminder to stick with the seasoned veterans.

On a related note, a number of earning reports and other interesting news came out last week. REITwrecks is looking forward to examining all those 10Qs, and more importantly, to writing about them. Thanks again for reading.

Disclosure: Long RAS, AHR and NRF. SFI position in the works.

What's The Rub With RAS?

noreply@blogger.com (REIT Wrecks) — Thu, 24 Apr 2008 10:09:00 +0000

Things are looking up... The Wall Street Journal reported Wednesday that investors and issuers of commercial mortgage-backed securities have something to cheer about for a change: The CMBX, a two-year-old credit-market index that has been heavily influencing CMBS prices, has been on a tear since late March.

As REITwrecks wrote earlier, the index had been under the influence of short sellers and trading at levels that would imply default rates of as much as 100% of the underlying commercial mortgages. As the WSJ reiterated, this is an all-but-impossible scenario, and with the index now oversold, investors are starting to pay more attention to the fundamentals of the commercial-property market.

REITwrecks has been emphatic about this disparity between price and value: for a long time, a myopic Mr. Market simply got it very, very wrong. Superficial similarities between residential and commercial real estate just did not and do not exist, and he has discounted the instrinsic values of the cash flows associated with commercial real estate far too heavily as a consequence.

Goldman Sachs' CFO David Viniar underlined the point in a conference call with investors last month. "Many assets are being priced by the market at levels which are significantly below the levels that would stem from a fundamental valuation approach," he said, while blaming depressed prices on "technical contagion" that eventually will abate.

As if on cue, over the past several weeks, spreads between Treasury's and the AAA CMBX have tightened dramatically, which in turn has driven up the prices on actual bonds. According to the Wall Street Journal, the spread on the triple-A series 4 index, which tracks certain 2007 CMBS deals, has shrunk to less than a hundred basis points after almost reaching a 3-handle in mid-March.

"I see the rally as something that should have been expected given how far out of whack CMBX spreads had gotten versus stable commercial real-estate fundamentals," said Darrell Wheeler, global head of securitized strategy at Citigroup Inc.

In another rare sign of stability returning to the market, last week Lehman Brothers and UBS lowered some yields on $1 billion of commercial mortgage-backed securities in what may mark the first CMBS of 2008 to price at yields lower than those first pitched.

According to Reuters, Lehman and UBS lowered yields on the "AAA" rated portions by 15 basis points to 25 basis points without losing orders. Previous issues had been sweetened with additional yield to draw investors shaken by the credit crunch and concerned that commercial real estate would falter in a U.S. recession.

Signs that sentiment has begun to improve have also been seen in the secondary market for CMBS. Spreads on outstanding 10-year "AAA" bonds have dropped by 100 basis points in the past month, according to JPMorgan Chase & Co.

After spending a considerable amount of time at the bottom of the lake, even the CLO/CDO market is starting to slowly heave its chest again. Traders report an increased appetite for European CLOs in the secondary market, but that the interest remains hampered by the lack of supply - caused primarily by sellers who see value in the paper and are thus unwilling to sell at such wide spreads. Previously there had been a steady trickle of assets from credit funds, SIVs and other forced sellers, which satisfied interested buyers, but this now appears to have ended.

The groundwork is being laid for a recovery in the second half of the year, suggest structured credit analysts at JPMorgan, who contend that higher relative value now compensates for the risk of mis-timing the bottom. CLOs could actually be part of the solution, given that banks are using the vehicles to move loans off their balance sheets.

However, demand is nothing what it used to be, with two thirds of the market for CLOs, CDOs and MBS having been wiped out, and those investors that do remain have become even more sensitive to underwriting and the managers behind each deal. Track record is everything. Demand has thus not even come close to recovering from pre-crisis levels, if it ever will at all.

And this is the main Rub with RAS: even with cash flowing assets match funded with long-term, non-recourse liabilities, RAS has been cut off from the oxygen it needs to grow FFO. Thus, in one of the best markets in 20 years, RAS has very little room to maneuver for new, choice assets at these premium spreads.

Combine this with lingering doubts about the Trust Preferred portfolio, much of which is covenant-lite and exposed to less solid credits and, indirectly, even shakier markets (think Accredited Home Lenders), and you still have a lot of uncertainty. Consequently, even with Thursday's 7% jump, RAS is still trading near its credit-crisis nadir.

REITwrecks is conducting research on the Indian Ocean and will be relatively unplugged when RAS reports on May 5th, but mark-to-market is now old news. The issues to pay attention to now are the ability to fund growth (true for all REITs), and the health of the TruPs portfolio (RAS in particular).

As Lehman Brother's CFO said, "we look at the mark-to-market adjustments as more temporary in nature," the steep decline of mortgages and loans has been "driven by many technical factors, which may not reflect intrinsic value," she said.

Unfortunately, the true intrinsic value of RAS's TruPs portfolio is yet to be determined, and future value creation in this bountiful market hinges heavily on the Cohen's funding creativity. Watch for both on May 5th.

Disclosure: Long RAS

Conservative Investors: Apartment REITs Offer Safety Amid Market Turmoil

noreply@blogger.com (REIT Wrecks) — Thu, 24 Apr 2008 03:25:00 +0000

Despite the industry wide turmoil in REITs and real estate, the Multifamily Executive News Service reports that Apartment REITs seem to be faring well, according to a recent study from Standard & Poor's Ratings Services.

Things might not look as good as 2006 and 2007, but they still aren't bad, according to George Skoufis, S&P's primary apartment REIT analyst. "In 2008, we expect continued moderation but positive rent growth," he says. "From a fundamentals standpoint, we've seen moderation in rent growth and NOI growth."

Green Street Advisors, based in Newport Beach, Calif., also studies the REIT market and sees positive growth potential. The firm projected that revenue growth would hit 3.8 percent coming into the year, but those projections have since fallen back to the 3.5 percent mark.

"Apartment REITs overall this year should still achieve positive revenue growth, even in the face of a mild recession," says Haendel St. Juste, an analyst with Green Street. "Despite a slowing economy and an increased supply of single-family and condo "shadow rentals" in certain markets, the supply/demand picture is still in pretty good balance."

Skoufis sees the for-sale market troubles as one of the biggest boosts to the supply/demand equation. "Homeownership is coming down," he says. "That will benefit the multifamily sector."

Even with a slight recession, St. Juste thinks multifamily will hold up. "Demand will still be driven from household formation, a declining homeownership rate, and Echo Boomer demand," he says. "Even in periods of very weak job growth, new household formations tend to bottom out at around 500,000 per year, a result of an ever-growing population."

All of these factors help the REITs, of course. S&P sees AvalonBay (BBB+/Positive), Equity Residential (A-/Stable), and Camden (BBB+/Stable) as setting the pace for the multifamily sector, though it recently downgraded both AvalonBay (for its large development pipeline) and Equity (for not having debt protection).

Although BRE Properties (BBB/Stable), Essex Property Trust (BBB/Stable), Post Properties (BBB/Credit Watch) and UDR (BBB/Stable) were at the bottom of the REITs list, Skoufis says they're still fairing well compared to other sectors.

"They're solidly investment grade," Skoufis adds.

Amplifying this point, the National Association of Real Estate Investment Trusts (NAREIT) reported that Residential REITS were the second best performing REIT sector in the first quarter of 2008.

Apartment REITS, which comprise most of the Residential REITS (the balance is composed of manufactured housing REITs), were up 12.29 percent year-to-date. Residential REIT returns increased 11.20 percent in the first quarter. These are impressive figures compared with the Dow Jones Industrials which was down 7.55 percent to start the year.

Apartment REITs' total returns compare favorably with the those of the U.S. REIT market, which was nearly flat for the first quarter of 2008. (The FTSE NAREIT All REIT Index was down 0.42 percent, while the FTSE NAREIT Equity REIT Index was up 1.40 percent.)
By contrast, other market benchmarks dove into negative territory to start the year.

Other than the Dow Jones Industrials, the S&P 500 was down by 9.44 percent, the Russell 2000 dropped by 9.90 percent and the NASDAQ Composite was lower by 14.07 percent.
REIT performance accelerated in March, as the FTSE NAREIT All REIT Index was up 3.88 percent in the month.

“The sub prime mortgage crises did not have a direct negative impact on apartments but did in fact have an indirect positive impact,” says Brad Case, VP of research and industry information at NAREIT. “All those people who could not afford to buy homes had to start renting apartments.”

This, Case believes is the reason Apartment REITS are a safe way to play the real estate meltdown.

“Fundamentals in the REIT industry are pretty strong and there is no real sign that they are likely to weaken anytime soon,” Case concludes.

For more, see "Even Ben Stein Likes REITs".

Bargain Hunters Circle European CMBS

noreply@blogger.com (REIT Wrecks) — Mon, 21 Apr 2008 16:26:00 +0000

LONDON (Reuters) - Banks and opportunity funds are hunting for bargains among cut-price European Commercial Mortgage-Backed Securities (CMBS), raising hopes the debt market deep-freeze may be about to thaw.

Growing appetite for European CMBS could provide a breakthrough for banks desperate to free up loan book capacity by issuing new CMBS, which many see as a vital first step back towards cheaper and more flexible lending.

"CMBS is fantastically cheap. We see this as a once in a lifetime buying opportunity to pick up AAA-rated paper at amazing spreads," said Caroline Philips, Eurohypo's managing director of securitization in Europe.

The once-thriving CMBS market has been comatose since last summer's credit crunch triggered a collapse in demand and enormous slack in spreads.

Credit Suisse data from March 27 showed European CMBS cash spreads were 240 basis points over the London Interbank Offer Rate (LIBOR) at AAA level and 750 basis points over at BBB, which Philips said was basically pre-credit crunch prices "with a zero on the end".

Philips said Eurohypo, which is better known for its CMBS issuance activities, was in the middle of an acquisition spree motivated by "no-brainer" AAA CMBS pricing.

"We have bought around 100 million pounds worth of CMBS in recent months but we want to do more," she said, adding that the bonds were bought with a view to holding to maturity because potential returns on equity were "enormous".

Spreads at their current magnitude could indicate huge problems with the underlying credit but some investors say the CMBS sector has been hit too harshly by fallout from the U.S. subprime residential mortgage crisis and the long-anticipated end of a European property market boom.

"...Even with pressure on property values, there is currently no great pressure on security of rental income, so unless a loan is due for imminent refinancing, the loan will still be kept current...the bonds will still pay," said Philips.

The young market for European CMBS saw the biggest output of issuance between 2005 and H1 2007, with around 135 billion euros of bonds issued, European Securitisation Forum data showed. Issuance dived to 10.7 billion euros in the second half of last year.

The bulk of these were structured on five and seven year loans and are not due for refinance until 2010 at the earliest, the same year the property derivatives market is banking on a recovery in UK property values.

"If you look at the real estate fundamentals -- expected vacancy rates, yield movement -- this downturn is not expected to be as bad as the last... The message we need to put across is this is not going to be the next U.S subprime sector. There will be no meltdown," said Philips.

OPPORTUNITY KNOCKS

Cash-rich opportunistic buyers are also tempted by CMBS, adding to downward pressure on spreads.

Many of these funds are drawn by the chance to make double-digit returns on equity -- returns that are now harder to grasp in bricks and mortar buys after a sharp slowdown in property capital value growth.

"We're looking closely at buying CMBS on behalf of investors," said one senior European real estate investment banker, on condition of anonymity.

"They may be traditional buyers of assets but debt looks so cheap at the moment. If you do not need to mark-to-market in your portfolio and you can buy AAA at 300 basis points and hold to maturity then that's a hell of a good buy," he said.

Marc Mogull, founder of opportunity fund manager Benson Elliot Capital Management, said he was confident European CMBS prices had "bottomed".

"Opportunity funds go where the opportunities are and I'd expect all are sniffing around the European CMBS space right now," Mogull said.

Mogull said he believed current AAA spreads "were not a fair reflection" of their repayment prospects and that a repricing of risk across BBB and sub-investment grade paper had been "indiscriminate", leading to pockets of real value.

Trading has been hamstrung by a standoff between buyers and sellers over price, but Mogull said the market was close to a clearing price that could jumpstart transaction volumes and help banks to cut burdensome property loan positions.

"My view is that BBB paper will clear at spreads of 800 to 1000 basis points ... From a default perspective, AAA's look outstanding value at close to 250 basis points, even ungeared. Once people see prices sticking at these levels, we'll see the backlog start to move," Mogull said.

Brenna O'Roarty, director of European Strategic Research at Deutsche Bank's property arm, RREEF, said she felt CMBS were blighted by "branding" but had potential to bounce back.

"If you look beyond the label of CMBS and focus on the coupon and the risk attached to that coupon, CMBS can look like good value," she said.

High Yield Mortgage REITs: The Perfect Storm?

noreply@blogger.com (REIT Wrecks) — Fri, 18 Apr 2008 03:21:00 +0000

Volume of Maturing Mortgages to be Low in 2008 and 2009, Reducing Refinance Risk Even Further, but Mark to Market is Discounting REITs to the Depths of Atlantis.

After a couple of alarming headlines in Seeking Alpha related to commercial real estate, the most recent of which was "Commercial Real Estate Collapsing", REITwrecks decided to do some digging. Sherlock Holmes may have had Watson, but who better than REITwrecks to sleuth the truth in real estate?

One of the first articles appeared last week and was prompted by a study issued by the Johns Hopkins Carey School of Business on the short term future of commercial real estate markets. Despite Seeking Alpha's clumsy attempt to connect the report to potential nation-wide troubles, the report actually focused almost entirely on the the Baltimore/Washington area, and then primarily on certain development projects within that area.

It was a comprehensive report, but with such a narrow focus it hardly qualified as meaningful commentary on the market as a whole. In addition, the John's Hopkins report itself was very positive overall.

However, the SA article focused on the negative comments of several experts, who worried that the Baltimore-oriented report was overly optimistic. One of those experts was David Fick, who covers REITs for Stifel Nicholas. For that reason, the story deserved further attention, and that attention exposed some very interesting market data.

According to the story, Fick said that $236 billion in equity investments have already been written off as a result of the subprime mortgage crisis, and that "most of that investment has been in the commercial, rather than the residential, market". By the end of the credit crunch, he said he expects to see at least $400 billion in write-offs.

“The oxygen, the mother’s milk of commercial real estate, is capital,” he said in the article. “Try to get a construction loan now — it’s virtually impossible.”

In one of the more confusing paragraphs, the article quoted Fick as saying that "more 10-year, commercial mortgage-backed securities were issued in 1998 and 1999 than ever before, and that most of them would not be financed". I'm not sure what that means, but Fick went on to predict that the result would be "the demise of many of the region’s existing real estate investment trusts within the year".

Unfortunately, the author didn't attempt to clarify whether Fick meant these deals wouldn't be financed in today's market, or whether these deals wouldn't be refinanced in today's market (as the loans mature). Asserting that a development deal would be more difficult to finance today's market is not particularly insightful, nor is it relevant to a question dear to the heart of REITwrecks: what is the health of Mortgage REIT portfolios, and is the market pricing the intrinsic value of these cash flows rationally?

So I continued an investigation into refinance risks that resulted in a previous article, which disclosed that 99% of all CMBS deals maturing since the credit crunch began in August had been successfully refinanced. Thus, the supply of credit for commercial real estate appears to be holding up even in this credit-stressed environment.

Alas dear readers, that good news on supply is naturally only one side of Adam Smith's beautiful yet invisible hand, and REITwrecks unintentionally left some astute readers clinging frantically to their mousepads for even more. What about the demand side for credit in this environment? More importantly, would a huge supply of maturing paper in need of refinancing put even more pressure on the commercial real estate debt market?

I found the exact opposite to be true. According to a report issued by the Mortgage Bankers Association, the volume of maturing mortgages will be low in the coming years, which would expose few commercial loans to these refinance risks.

"There's been a general impression that a large volume of commercial/multifamily mortgages are coming due this year and next," Jamie Woodwell, MBA's senior director of commercial/multifamily research, said. "The reality is that 2008 and 2009 will see a relatively small volume of maturing mortgages, with the majority of CMBS loans not maturing until 2015 or later."

Capturing data from JPMorgan and Wachovia Capital Markets, the report found that there is more than $600 billion of outstanding loans in fixed rate commercial mortgage-backed securities (CMBS). Of this, only $16 billion is scheduled to mature in 2008 and another $19 billion in 2009.

The surge in sales, financing and refinaning volume during 2005, 2006 and 2007, coupled with the fact that CMBS loans tend to have a 10-year term, mean that the majority of CMBS loans will not mature until 2015 or later -- $98 billion of loans are scheduled to mature in 2015, $128 billion in 2016 and $127 billion in 2017.

Of the loans due in the coming years, the majority is well seasoned and have been amortizing, meaning that they now have lower loan-to-value ratios and will be more attractive to lenders. JPMorgan reports that $14 billion of the $16 billion maturing in 2008 is fully amortizing, as is $14 billion of the $19 billion coming due in 2009. According to Wachovia Capital Markets, more than two-thirds of the volume of loans coming due prior to May 2009 was originated prior to 2000.

In addition to the fixed-rate conduit deals described above, the report noted that Wachovia Capital Markets has identified $30 billion of large-loan floating-rate deals that will be coming due prior to May 2009. The maturity dates of these loans are spread throughout the period, with relatively larger volumes -- $3.5 billion and $3.3 billion, respectively -- coming due in August and October 2008.

These numbers all appear to be manageable given Fitch's report that over $21 billion in CMBS fixed rate loans had been refinanced just since August of 2007, when the credit crunch began.

The MBA report focused on maturing mortgages in the same CMBS market. Banks and thrifts will be more likely to have shorter-term and adjustable-rate loans, while life companies will tend to have longer-term fixed-rate loans, but with much lower leverage and thus easier to refinance. Each group's maturity patterns will also be affected by the ups and downs of its originations experience, but each group's originations generally fell as the CMBS market grew.

So what we appear to have is the equivalent of a hurricane hitting during a spring tide. The storm's turbulence is no less intense, but the extremely low tide is preventing the storm waters from getting anywhere near the beach.

Nevertheless, the market is pricing a force 5 hurricane hitting during a full moon flood tide, and it is conspiring with mark to market accounting to discount prices by Poseidon-like proportions. The resulting price dislocation is almost unprecedented, and for long-term, opportunistic investors it really is the perfect storm.

Dividends Under The Bridge? Markit Responds to CMSA

noreply@blogger.com (REIT Wrecks) — Mon, 14 Apr 2008 15:40:00 +0000

In responding to the Commercial Mortgage Securities Association's ("CMSA") letter regarding increased transparency on CMBX trading, the Markit Group (the administrator of the CMBX indices) has apparently responded with a modern-day version of "Frankly my dear, I don't give a damn."

Evidently, Markit is contending that since the CMBX trades on the OTC derivatives market, Markit does not have access to trading data (either volumes and/or number of daily trades).

They also pointed out that trading volumes have never been published for other OTC derivative products (e.g. rates, FX, commodities), except for general surveys by ISDA, so it's unlikely that precise CMBX volume and trading data would ever be known. This would be good news for the speculators who make a living off of playing the index, and who now appear to be unloading their short positions.

I wrote about how all this is creating a the mother of all dislocations for REITs and financials in the recent article How Markit Turned Mr. Market into Mr. Magoo and much earlier in a March article entitled Mr. Market Trips on Mark to Market.

With respect to mark-to-market accounting, Reuters reported that Fed Chairman Ben Bernanke recently threw his policy-making heft behind the "if it ain't broke don't fix it" crowd in declining to recommend changes to mark-to-market.

According to Reuters, when asked about the issue in a question and answer session, Bernanke said that on balance mark-to-market has worked well, but "it's also true in the current context, that mark-to-market accounting has been sometimes destabilizing in that sales of assets into very illiquid markets had led to reductions in prices, which have caused writedowns which have sometimes caused firesales, and you get into an adverse dynamic which has caused problems in some of our markets,"

While he said mark-to-market accounting has been a positive influence for investors, he also said that valuations should be determined during normally functioning, stable markets, not times when assets are illiquid.

Dottie Cunningham, CEO of CMSA, expressed the same concern in the CMSA's original letter to the Markit Group. "In a volatile market, this mark-to-market process becomes a self-fulfilling prophecy, driving prices down based on index trading activity rather than asset fundamentals," she said. "Some market participants may be relying on what we believe is a distorted value that perpetuates the current cycle of no issuance, erroneous spread widening and additional mark-to-market write downs."

So what can Markit expect next from the CMSA? Perhaps it will be a modern-day version of "I'll get you my pretty". Fortunately, for far-sighted investors who can stomach the turmoil and almost daily drumbeat of bad news, it really doesn't matter. As Bernanke said, mark to market has been good for long-term investors.

In an act of self-healing triage, the market has put itself on sale, and this will almost certainly cause liquidity and prices to recover. It will take some time, but at this point and with these discounts, the recovery may shift into higher gear sooner rather than later. In the meantime, you get paid to sit and watch the show.

Bloomberg: PIMCO Big Buyer of Mortgages

noreply@blogger.com (REIT Wrecks) — Thu, 10 Apr 2008 20:49:00 +0000

Several days ago, I posted that Morgan Stanley CEO John Mack likes mortgages. However, Bill Gross and his PIMCO Total Return Fund are definitely putting their money where his mouth is.

According to Bloomberg, the $125 billion fund increased mortgage debt holdings to the highest level since 2000. Bloomberg says the fund had 59% of its assets in mortgages in March, which is up from 52% in February and just 23% in March of 2007. Simultaneously, he put on a very bearish bet on Treasuries.

Don't tell me the bottom bottomed and we missed it!

The full story is here

Risk Rising on Alesco's REIT Status

noreply@blogger.com (REIT Wrecks) — Wed, 09 Apr 2008 17:55:00 +0000

CDOs are back in the headlines - again. The old story is that they are defaulting in record numbers. Indeed, few now seem to be generating any income for anyone, except for the lawyers that are now starting to unwind them. And that is the new story: increasing numbers of defaulted CDOs are now being completely liquidated.

As of March 31st, S&P reported 141 CDO events of default with all but two coming from the 2006/2007 vintages. By volume, US$157bn or 44% of 2006/2007 CDO issuance is in technical default.

According to S&P, thirteen CDOs are reportedly now in liquidation, while fifteen deals have already been liquidated. A total of 8% of 2006/2007 issuance is in some form of liquidation (14% mezzanine, 4% high grade and 12% CDO-squared). Those in the acceleration phase tally 16% (27% mezzanine, 11% high grade and 6% CDO-squared). CDO squared deals are those CDO deals that invested in other CDOs. Just think Jurassic Park and you'll have it about right.

S&P said that liquidations would probably start to increase, and that structured finance CDOs and CDO-squareds from 2006 and 2007 are "the most vulnerable" to events of default (yet more reason to stick with the seasoned veterans in Mortgage REITs) and possible liquidation following an event of default. Liquidations would be the end of the line for these troubled CDOs.

S&P's report was prompted by a ratings action which lowered the ratings on 33 classes of notes - worth US$3.6bn - from across four ABS CDO transactions to single-D (far below CCC, the dreaded "triple hook" for investors), following news that the trustees had liquidated the portfolio collateral and have distributed or are in the final stages of distributing the proceeds to noteholders.

What is most interesting with respect to Alesco (AFN) is that S&P said the trustees for the four CDOs do not anticipate that the proceeds from the sale of the collateral (including the principal collection account, any proceeds in the super-senior reserve account, the CDS reserve account, etc.) will "be adequate to cover the required termination payments to the CDS counterparty, and that it is likely that proceeds will not be available for distribution to the notes junior to super-senior swap in the capital structure of the CDO transactions." Hence the downgrade to single D.

While this structure is a little different than the Alesco CDOs, "super senior" means just that, and the trustees are not only indicating that the sale proceeds will be insufficient to make distributions to anyone junior to them, the text of the trustee's notice also indicates that there may not even be enough value in the collateral to satisfy the capital structure's king of the hill!

The fact that Alesco's REIT status is at risk is really not news. Alesco has been relying on its Kleros CDOs to help satisfy its REIT qualification tests, and their default has put that qualification test in doubt. To say that the issue dominated the discussion during last quarter's conference call with management would not be an overstatement.

AFN management also indicated during that call that continuing to meet the REIT classification would not be an issue, and that they were working on ways to replace the Kleros income. However, increasing rates of liquidation would finally put these crippled CDOs out of their misery, and it puts Alesco in an increasingly hot foot race with the Kleros noteholders and their lawyers.

Maintaining REIT status is important to investors because it requires those entities that claim it to distribute a minimum of 90% of taxable gross income to shareholders. The REIT laws were developed by the Treasury to encourage capital formation around housing and commercial real estate, and it rewards this by not taxing REITs at the corporate level. Zero taxes.

In return, REITs must derive 95% of their gross income from "real estate related activities". Real estate related activities has recently meant a lot of different things to a lot of different people, but to AFN it included the income on the spread between the assets held in the Kleros CDOs and the cost of servicing the Kleros notes paired to them.

Well, as it turned out there would be very little income generated by the Kleros assets. What remains is now being diverted to the senior noteholders, away from AFN, so there is no spread to collect, and the note holders - through the Kleros trustee - have declared an event of default on the notes for failure to meet the over-collateralization tests. The note holders do not have any recourse to AFN, so AFN's exposure is limited to its own net investment, which it has already written off anyway.

The Alesco story is nothing if not intriguing, and I would say it is one of the more interesting shows going on in the REIT world right now. It is run by the Philadelphia-based Cohen family, who run a veritable MacDonald's Farm of CDOs through the family of REITs they control. They have an experienced, qualified, and capable team, and to varying degrees they have also put their money where their mouth is with significant insider purchases. However, an even more significant insider purchaser pattern persisted at Thornburg Mortgage (TMA), and not even that commitment could prevent management's stakes from being vaporized into their worst dilutive dreams.

Also, as I wrote in an earlier article, the mark to market write downs on AFNs assets alone have been so substantial that just by adopting FAS 159, which AFN plans to do, AFN would add approximately $2.7 billion in GAAP book value, or $45.03 per share, to stockholders equity. Much of that comes from writing down the liabilities paired with the already cratered Kleros CDO assets that are the subject of this post. Some of it also comes from investments in Trust Preferred's issued by regional banks and mortgage lenders, and that part of the portfolio may be the next shoe to drop.

Ignoring the Trust Preferred issue (some TruPs were bought from regional banks with heavy exposure to local home builders), there may be about $6-$7 dollars in GAAP book value left when all is said and done. Because AFN's assets are almost all match funded with long-term, non-recourse debt, what value remains continues to be safe from margin calls.

Nevertheless, because REIT status guarantees that investors receive the majority of taxable income generated by those assets, however meager they may be in AFN's case, most investors do not underestimate the claim on earnings that REIT status affords them, and nor should you.

If, as S&P postulates, the risk of CDO liquidations is rising and that the 2006/2007 vintage CDOs are the most vulnerable, this would put the Kleros family of CDOs in an increasingly tenuous position. Because the noteholders are taking the trouble to liquidate these CDOs regardless of the value of the collateral, it heightens the risk of AFN losing its REIT status by eliminating its last "practical" line of defense against a total Kleros liquidation, which is: why would anybody bother?

Disclosure: None

Morgan Stanley's CEO Likes Mortgages

noreply@blogger.com (REIT Wrecks) — Tue, 08 Apr 2008 23:27:00 +0000

The media sentiment on the credit crisis looks like it's starting to turn from a dour play by play to furtive attempts at calling a bottom. In an earlier article, I wrote that the "rescue" of Bear Stearns may have been the last shoe to drop, because it signaled the Fed's determination not to let the credit crisis worsen. Who knows. But after all this bad news a bottom would be nice to contemplate, wouldn't it?

Along those lines, Morgan Stanley's CEO John Mack was quoted by the Associated Press as saying he thinks the market may in fact be bottoming. According to the article, Mack said that Morgan Stanley is also seeing opportunities in the very same mortgage market that caused most of Wall Street's pain. "I don't know if this is the bottom or close to the bottom, but at some point it will be wise to invest there."

The AP's full story is here.