SPRING 2012

RESEARCH PUBLICATION

Predicting CMBS Prepayments and Defaults

The Impact of Distressed Real Estate Loans on CMBS Performance
A research report prepared for the Steven L. Newman Real Estate Institute by Benjamin Polen, Senior Research Associate at the Institute.

CMBS is created by splitting the cash flow

issuances, as well as a high profile building, to illustrate risk to CMBS investors. Special servicer estimates and market information are applied to assess potential impacts on CMBS tranches. Ratings agency methodologies are applied to analyze current net operating income (NOI) and estimate refinancing proceeds. Investors can apply these same techniques to managing CMBS portfolios or when underwriting prospective CMBS investments.

I had been getting something for nothing. That only delayed the presentation of the bill. The bill always came.
~ Ernest Hemingway
The Sun Also Rises

from commercial mortgages into different bonds, known as tranches. Commercial real estate investors with an opportunistic strategy may appreciate how their skills can be used to identify pricing discrepancies that then impact structured real estate finance. Structured finance investors can use this article to appreciate the impact that unique attributes of individual real estate assets have on CMBS investments.

Introduction

C
check.

ommercial securities

mortgage-backed (CMBS) investors

Figure 1:
Three Columbus Circle

Risk
In a bullish real estate market, most investors expect both mortgages and structured CMBS to perform as originally modeled. When cash flows from real estate can no longer support the debt service due to a weak real estate market, this generates risk for CMBS lenders. CMBS tranches allow investors a choice of risk. Senior bonds offer lower yields, but are created with credit support, which has generally succeeded in insulating them from defaults. The CMBS issuance used as an example in this article, WBCMT 2006-C23, was created with 30% credit support. Junior bonds have less credit support but offer the opportunity for higher returns. Junior bonds will be the first to absorb any losses from defaults. Prepayment risk represents an early

have learned, if nothing else During the real estate boom,

than out of necessity, how to split the investors modeled senior CMBS bonds with minimal prepayment risk and were willing to discount the probability of losses to junior CMBS bonds. In todays distressed environment, CMBS investors face increased default and prepayment risk as a result of special servicers selling nonperforming loans and real estate owned (REO) properties. It is imperative for CMBS investors, or those who wish to gain knowledge of the subject, to understand how to evaluate both commercial mortgage credit and CMBS cashflows (or waterfalls) to translate these vague fears and worries into actionable information. This white paper uses special servicer data and ratings agency methodologies to analyze CMBS loans. By applying this analysis, investors are empowered to make their own determinations on pricing and risk for CMBS, essential tools for portfolio management and CMBS trading decisions (secondary CMBS).
Photograph credit: Benjamin Polen

return of principal, eliminating future interest cashflows that would otherwise be made to bondholders. This risk was thought to be generally mitigated by lockout periods, defeasance and penalty fees. given Rarely was serious consideration to substantial prepayments

Problematic deals that special servicers are now tasked with resolving are numerous. In fact, about 8% of all outstanding CMBS deals are delinquent as of September 2011, according to Morningstar. This article uses actual loans and CMBS

resulting from distressed sales. Investors

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PREDICTING CMBS PREPAYMENTS AND DEFAULTS

SPRING 2012

in todays CMBS market need to pay careful attention to default and prepayment risks and their impact influence on total returns.
1

material effect on the bond price and yield. For investors who bought into three to five year bonds with a perception of an AAA safe and steady yield, receiving a large principal prepayment could shorten the average life down to one to three years. This reduces both yield and total return.

Default risk stems from loan losses, ultimately correlated with a borrowers ability to refinance a loan, the causes of which are property specific. Recent property income information can be used to re-underwrite a loan from a lenders perspective and determine refinancing proceeds. If expected refinancing proceeds are less than the loan exposure, CMBS investors face default risk. In CMBS, nonperforming mortgages are sent into special servicing, where a special servicer (predesignated at CMBS issuance) decides whether to engage in a workout, sell a nonperforming note or foreclose (leading to REO). Each of these decisions will have a different effect on CMBS investors. Understanding special servicer decisions and the resulting impact on CMBS is key for investor underwriting. For example, a note sale results in an unexpected cash inflow, but the servicer is obliged to distribute cash according to the structured formula. This was the case at Three Columbus Circle, as detailed in the next section of this paper, when the loan sale resulted in a prepayment. Another option for a special servicer is a workout or modification. One modification technique that has been used frequently is a loan extension on the same terms, such as a one, two or three years. While a loan extension can help keep a borrower current, it does so at the continued risk to CMBS investors. Principal payments, including prepayments resulting from an REO or loan sale, flow first to a senior bond. Cash proceeds resulting from a loan or property sale are distributed to the CMBS tranches that are first in line to receive principal payments. In the event of a significant principal prepayment, this can have a
These risks are formally known as constant default rate (CDR) and conditional prepayment rate (CPR).
1

How a NYC Office Loan Impacts CMBS

In New York, the $250 million securitized loan on Three Columbus Circle (aka 1775 Broadway, the former Newsweek building) and its sponsor, Joe Moinian, is familiar to many real estate professionals. The Three Columbus Circle loan was securitized into WBCMT 2006C23. The building, shown in Figure 1, underwent an extensive renovation and repositioning process, which resulted in a low occupancy of 68% as tenants left during the disruptions. The mortgage was sold to the Related Companies by special servicer CW Capital, resulting in a large $250 million prepayment to senior CMBS investors. (SL Green later partnered with Moinian in a recapitalization and paid off the Related-owned mortgage.) While junior CMBS investors were protected from a loss, senior bondholders saw the market price of their bonds drop as a result of the reduction in interest cashflows. This effect is illustrated in Figure 2. The repayment and the impact on senior bondholders could have been predicted through an understanding of structured finance and the CMBS issuance. The CMBS loan on Three Columbus Circle, originated in 2006, was structured with a four-year, interest-only period and a scheduled amortization period starting in February 2010. This amortization increased debt service by 20%, from $14.4 million to $17.4 million. According to press reports, when Moinian was unable to refinance the building, he hoped to negotiate an extension of the interest-only period. In order to do so under CMBS structure, it was necessary to deliberately skip loan payments in order to transfer the loan into special servicing. Unlike bank lending, a CMBS borrower cannot rely on a transactional

Figure 2:
WBCMT-C23 Senior Bond Prices via Bloomberg Data History (BDH)

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PREDICTING CMBS PREPAYMENTS AND DEFAULTS

SPRING 2012

Figure 3:
Cumulative CMBS Losses by Vintage (Bloomberg)

the bonds performance activity.2 At Three Columbus Circle, plausible prepayment scenarios would certainly include the payment of the full $250 million amount. What if the special servicer had extended the loan? CMBS bondholders will have different viewpoints depending on the tranche owned. Distressed real estate loans held inside a CMBS conduit may be resolved in several ways by the special servicer, including an outright sale of the loan or foreclosure and sale of the real estate asset. Besides a sale of the loan (or foreclosed property), other resolution strategies include a modification of loan terms, an extension of balloon payment or receivership. Each will have a different impact on bondholders. In this case, a loan extension would have helped the senior A-PB tranche, which would not have taken such a large prepayment and subsequent hit on its market price (Figure 2).

Exploring CMBS Risk

relationship or goodwill in a workout. In this instance, the missed payments triggered a material default of the loan. A loan modification is generally employed when there are few other palatable alternatives, including a lack of interested buyers and the inability to refinance. Given market reports about the borrowers various failed attempts to refinance the loan, he may have viewed this as a sign of the markets lack of appetite for the collateral. A calculated risk of withholding loan payments to force a modification may have been rational, but perhaps it was the borrowers only choice. From the special servicers perspective, tasked with maximizing proceeds to the trust, selling this loan quickly was an easy choice to make. To date, 2006 vintage CMBS deals have had the second highest losses (Figure 3). The ability to identify likely loan resolution outcomes is the first step to estimating the impact on CMBS. For example, an analysis of the distressed loan on Three Columbus Circle could reasonably determine sufficient demand for the first mortgage loan, based on the propertys location, size and loan to value (LTV) ratio. With a loan balance of $250 million, this represented a collateralization of $404 loan/square foot. Even with additional required redevelopment costs, this opportunity is a compelling deal, given the propertys frontage on 57th Street and its proximity to Columbus Circle. It is therefore a reasonable possibility that the special servicer could sell the loan at or near its par value of $250 million. The next step is in understanding the impact of a $250 million prepayment would have on the CMBS trust. In The Handbook of Mortgage Backed Securities, Jacob, Manzi, and Fabozzi wrote, For large loan pools, CMBS investors should identify the loans that influence a given bond the most and then develop plausible prepayment scenarios to reveal Real estate professionals can use their market knowledge to estimate the likelihood of prepayments and losses on CMBS conduits. For example, applying market cap rates to property income will derive a property value. A loan amount, based on 65% loan-to-value ratio, can then be backed out of the property value. Alternatively, one could apply a required debt service coverage ratio and interest rate to determine the propertys ability to support a refinancing. When refinancing proceeds are less than the loan balance, loss and prepayment estimates are applied to their corresponding junior and senior tranches. Near-term (within 12 months) prepayments and losses are most likely to immediately occur from the sale of properties or delinquent loans
Handbook of Mortgage Backed Securities, Chapter 50, The Impact of Structuring on CMBS Bond Class Performance by David P. Jacob, James M. Manzi and Frank J. Fabozzi.
2

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PREDICTING CMBS PREPAYMENTS AND DEFAULTS

SPRING 2012

controlled by the special servicer (as was the case with Three Columbus Circle). Fortunately, it is possible for investors to access the information maintained by special servicers that describes both delinquent loans and foreclosed properties, also known as the previously mentioned REO.

Figure 4:
WBCMT 2006-C23 REO & Potential Losses based on Special Servicer Estimates as of September 2011 (Special Servicer Report)

REO Generates High Prepayment Risk

REO assets are destined to be sold by the special servicer, most likely in the near term. While it is true that a special servicer may hire a management company to lease a REO property and attempt to increase the property value, this strategy can take more than a year to implement. Thus, REO properties provide the highest likelihood for prepayment. According to the special servicers reports on WBCMT 2006-C23, there are eight REO loans with a total principal balance of $87.7 million and a total loan exposure of $98.6 million.3 The special servicer estimates REO sales at 90% of the most recent value, which would result in a prepayment of $57.8 million (Figure 4). As a result, there is a total potential loss risk estimated at $40.8 million (Table 1), representing the shortfall between sale proceeds and total loan exposure. The $57.8 million of cash flow would go to the senior tranches and repay servicer advances. Considering the current balance of the senior A-PB tranche is $66.4 million, this prepayment would pay down 87% of that bonds principal balance (Figure 6). Senior bond investors would suffer from high principal repayments and risk an inability to replace those yields in current markets. The losses of $40.8 million
3 The total exposure balance reflected in REO could result in a $57.8 million prepayment to senior tranches, and write down the junior tranches with $40.8 million in losses.

Table 1:
WBCMT 2006-C23 loss & prepayment risk from delinquent and REO loans as of September 2011

the loss estimates includes advances made by the special servicer. These advances include principal and interest, along with property management and loan sale expenses. Since proceeds from a loan sale are first used to repay servicer advances before paying down bond classes, a long, drawn out and expensive loan battle can hurt recoveries to both junior and senior investors. In WBCMT 2006-C23, the REO loans have a total of $10.9 million in servicer advances.

Loan Status REO Delinquent Total Deal Name

Loss Risk $40,811,082 $53,751,743 $94,562,824 Loss Risk ($72,044,342) Ranking 1

Prepayment $57,775,500 $112,197,899 $169,973,399 Deal Name WBCMT 2006-C28

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REO Loa Balance

WBCMT 2006-C28

$318,034

PREDICTING CMBS PREPAYMENTS AND DEFAULTS

SPRING 2012

Figure 5:
WBCMT 2006-C23 Potential Losses from Delinquent Loans based on Special Servicer Estimates as of September 2011. (Special Servicer Report & authors analysis)

would write down the balance of the junior tranches, wiping out the entire balance of the most junior S tranche (Figure 7). Applying this analysis to the CMBS universe, a review of the ten largest REO loans shows the CMBS deals and their corresponding risk exposure (Table 2). The REO with the largest loan balance is a mall in California, built in 1968. The CMBS trust has $190 million in loan exposure, but the special servicer estimates the property valued at $153 million, a $37 million deficit to the loan balance. However, a portfolio of Southeast office buildings has the greatest loss risk of REO loans, with $68.3 million in loss exposure on a $180.9 million loan that is valued at only $112.64 million. Investors in those CMBS deals should be cognizant of the prepayment and default risk at hand. The CMBS deals associated with those loans have some of the highest REO loan balances and REO loss risk exposures (Tables 3 and 4). The prepayment risk to specific CMBS bonds is noted in these tables. The largest REO loan balance, the California mall,

Loan Status REO Delinquent Total Deal Name

Loss Risk $40,811,082 $53,751,743 $94,562,824 Loss Risk Ranking

Prepayment $57,775,500 $112,197,899 $169,973,399 Deal Name REO Loan Balance Ranking

would prepay the A2 bond of the WBCMT 2006-C28 issuance.

Deal Name portfolio,

The REO loan with

the greatest risk loss, the Southeast office

Foreclosure Loan would prepay JPMCC 2005-CB13

A2FL. The JPMCC 2005-CB13

Bloomberg CMBS tool makes $167,946,611

Balance

it easy to identify prepayment $127,777,001 risk up the BACM 2006-5 WBCMT 2006-C28 ($72,044,342) 1 WBCMT 2006-C28 $318,034,342 1 JPMCC 2005-CB13 ($68,260,000) 2 JPMCC 2004-CBX $88,000,000 JPMCC 2005-CB13 $180,900,000 2 collateral chain, from loan to CMBS deal. GSMS 2006-GG8 ($65,405,189) 3 GSMS 2006-GG8 $179,805,189 3 GSMS 2005-GG4 $83,125,000 CWCI 2006-C1 ($56,030,399) 4 Delinquent Loans $70,988,785 Are Troublesome, CWCI 2006-C1 $110,753,000 4 GMACC 2006-C1 GCCFC 2005-GG5 ($43,027,073) 5 GCCFC 2005-GG5 $107,753,000 5 Special Servicer Options GCCFC 2005-GG3 $67,727,758 BACM 2005-3 ($38,785,404) 6 6 million in Delinquent loans could result in a $112 million prepayment to senior BACM tranches 2005-3 and a write down of the $96,500,000 junior tranches with $53.8 CSMC 2007-C1 $64,000,000 CSFB 2001-CKN5 ($37,875,000) losses. (Note: Two loans are not expected to have losses.) 7 CSFB 2001-CKN5 $89,930,399 7 The next, or even equally risky basket of LBFRC 2006-LLFA $57,361,673 CGCMT 2007-C6 ($22,703,000) 8 CGCMT 2007-C6 $87,702,073 8 BACM 2006-1 $55,000,000 BACM 2006-4 ($22,701,636) 9 BACM 2006-4 $74,127,123 9 BACM 2005-3 $50,923,880 GSMS 2005-GG4 ($19,763,991) 10 GSMS 2005-GG4 $71,022,826 10 Table 2:
Rank 1 2 3 4 5 6 7 8 9 10 Loan Name Montclair Plaza(2) DRA-CRT Portfolio I Ariel Preferred Retail Portfolio Moreno Valley Mall FRI Portfolio Highland Mall Windsor/RECP Hotel Portfolio 55 Park Place Four Seasons Nevis Tower Place 200 Deal WBCMT 2006-C28 JPMCC 2005-CB13 GSMS 2006-GG8 CGCMT 2007-C6 BACM 2005-3 JPMCC 2002-CIB4 GCCFC 2005-GG5 BACM 2006-4 WBCMT 2007-WHL8 GSMS 2006-GG8 Target Bond A2 A2FL A2 A1 A2 A3 A2 A3A A1 A2 State CA Various Various CA Various TX CA GA Various GA Property Type Retail Office Retail Retail Office Retail Hotel Office Hotel Office Property Type Hotel Current Trust Balance $190,000,000 $180,900,000 $90,009,189 $84,565,377 $70,000,000 $61,104,416 $53,783,787 $51,303,123 $51,000,000 $50,500,000 Current Trust Balance $127,777,001 Recent Value $153,000,000 $112,640,000 $65,650,000 $42,700,000 $37,825,000 $128,000,000 $50,400,000 $42,000,000 $110,000,000 $27,050,000 Recent Value $113,120,000 Value Date 2/3/2011 n/a n/a 10/17/2011 8/19/2011 6/1/2001 12/16/2010 5/20/2011 9/27/2010 6/1/2011 Value Date 1/13/11 Loss Risk ($37,000,000) ($68,260,000) ($24,359,189) ($41,865,377) ($32,175,000) n/a ($3,383,787) ($9,303,123) n/a ($23,450,000) Loss Risk ($14,657,001)

Name Deal P: Rank 646.660.6950 / 137 Loan East 22nd Street, New York, NY 10010 www.baruch.cuny.edu/realestate 1 Trinity Hotel Portfolio BACM 2006-5

Target Bond A2

State 5 Various

ACM 2005-3

ACM 2006-1

ACM 2006-5

$127,777,001 $107,030,785 $88,000,000 $70,988,785 $64,000,000 $56,100,000 $55,000,000 $49,058,499 $45,371,159 $42,200,000
Prepayment $57,775,500

SMC 2007-C1

CCFC 2005-GG3

MACC 2006-C1

SMS 2005-GG4

rent Trust alance

90,000,000 80,900,000 90,009,189 84,565,377 70,000,000 61,104,416 53,783,787 51,303,123 51,000,000 50,500,000
REO

MCC 2004-CBX

MCC 2005-CB13

Loan Status Loss Risk PREDICTING CMBS PREPAYMENTS AND DEFAULTS Delinquent

rrent Trust Balance

FRC 2006-LLFA

Deal Name

Prepayment

SPRING 2012

82

$40,811,082 $53,751,743 $94,562,824

$57,775,500

43

Table 3:
Deal Name

$112,197,899

24

$169,973,399 CMBS deals with largest REO balance REO Loan Balance

Table Total

4:

$112,197,899 estimates described herein. $169,973,399

Recent Value

Recent Value

ng

Ranking 1 2 3 4 5 6 7 8 9 10

Investor Target Identification & Analysis Deal Bond State Property of Curr Current Trust Recent Value Value Date Loss Risk Type Ba Distressed CMBS Loans Balance 1 Montclair Plaza(2) WBCMT 2006-C28 A2 CA Retail $19 Table 5: A2 MT 2006-C28 CA Retail $190,000,000 $153,000,000 2/3/2011 After REO loans, an $18 2 DRA-CRT Portfolio I JPMCC ($37,000,000) 2005-CB13 A2FL and delinquent Various Office CC 2005-CB13 A2FL Various Office $180,900,000 $112,640,000 n/a 2006-GG8 ($68,260,000) A2 WBCMT 2006-C23 loans with debt service coverage under as of September 2011 3 1.0 Ariel Preferred Retail Portfolio GSMS Various Retail investor can identify other problem CMBS $9 S 2006-GG8 A2 Various Retail $90,009,189 $65,650,000 n/a ($24,359,189) $8 4 Moreno Valley Mall CGCMT 2007-C6 A1 CA Retail loans. The next most immediate concern Loans Reported DSCR Loan Est. Prepayment Est. Loss $84,565,377 $42,700,000 10/17/2011 ($41,865,377) MT 2007-C6 A1 CA Balance Retail 5 FRI Portfolio BACM 2005-3 A2 Various Office $7 is from other troubledTX loans that are likely $6 M 2005-3 A2 Various Office $70,000,000 $37,825,000 8/19/2011 ($32,175,000) 6 Highland Mall JPMCC 2002-CIB4 A3 Retail 0 to .24 $34,588,791 $34,864,221 7 $543,958 CC 2002-CIB4 A3 TX Retail $61,104,416 $128,000,000 6/1/2001 to be n/a classified as delinquent or perhaps $5 7 Windsor/RECP Hotel Portfolio GCCFC 2005-GG5 A2 CA Hotel FC 2005-GG5 CA $27,554,229 Hotel $53,783,787 $50,400,000 12/16/2010 ($3,383,787) 3 .25 to .49 A2 $23,970,097 $3,584,132 8 55 Park Place BACM 2006-4 A3A GA Office transferred to the special servicer through $5 M 2006-4 A3A GA Office $51,303,123 $42,000,000 5/20/2011 ($9,303,123) A1 WBCMT Various Hotel $5 9 Four Seasons Nevis .50 to .74 $279,996,485 $247,049,267 $32,947,218 9 2007-WHL8 foreclosure. A quick and helpful way to MT 2007-WHL8 A1 Various Hotel $51,000,000 $110,000,000 9/27/2010 10 Tower Place 200 GSMS 2006-GG8 n/a A2 GA Office $5 $325,251,138 .75 to .99 A2 $78,864,315 $27,050,000 S 2006-GG8 GA $404,115,453 Office $50,500,000 6/1/201125 ($23,450,000) determine which loans fall into this category
Est. Loss $543,958 $3,584,132 $32,947,218 $78,864,315 Est. Prepayment $34,588,791 $27,554,229 $279,996,485 $404,115,453

Rank Loan Name State coverage Property Cu isDeal by looking Target at the Bond debt service $115,939,623 $631,134,724 44 Property Current Trust Recent Value Value Date Loss Risk Type ratio of the loan. For the WBCMT 2006Type Potential losses and prepayments are estimated using Moodys methodology Balance 1 Trinity Hotel Portfolio BACM 2006-5 A2 Various Hotel $ C23 securitization, there are 44 loans with a BACM 2006-5 A2 Various Hotel $127,777,001 1/13/11JPMCC ($14,657,001) 2 The Shore $113,120,000 Club 2005-CB13 A2FL FL Hotel $ JPMCC 2005-CB13 FL2006-C23 Hotel $107,030,785 $91,500,000 12/14/10 ($15,530,785) debt-service coverage ratio of 1.00 loans in CMBSA2FL and WBCMT are known servicer 3as delinquent Continentalloans. Plaza The special JPMCC 2004-CBX A5 NJ (DSCR) Office JPMCC 2004-CBX Office $88,000,000 $50,300,000 ($37,700,000) A3 Retail 4 DDR/Macquarie Mervyns GMACC or2006-C1 less.5 These loans have Various a current balance has discretion A5 to choose aNJ resolution of delinquent loans and may choose Portfolio to 12/20/10 sell a loan GMACC 2006-C1 A3 Various Retail $70,988,785 $397,650,000 7/1/05 n/a 5 717 North Harwood Street CSMC of 2007-C1 A1A TX Office $746.3 million. There are 10 loans with (resulting foreclose on the property (leading to REO) or modify the loan (by($29,000,000) $35,000,000 3/24/10 CSMC 2007-C1 in prepayment), A1A TX Office $64,000,000 6 Investcorp Porfolio JPMCC 2005-CB13 A2FL PA Industrial a DSCR under 0.50 and with a cumulative extending a balloon for example). A loan modification JPMCC 2005-CB13 A2FL payment PA or scheduled Industrial amortization, $56,100,000 $46,850,000 n/aBACM ($9,250,000) 7 Fairmont Sonoma Mission Inn & Spa 2006-1 A2 CA Hotel BACM 2006-1 results A2 CA Hotel $55,000,000 $85,100,000 1/19/11 n/a loan balance of 5). typically in the loan being transferred out of and reducing the near 8 special Novoservicing Nordisk Headquarters CGCMT 2005-C3 A2$62.1 million NJ (Table Office CGCMT 2005-C3 A2 NJ Office $49,058,499 $32,200,000 3/1/11 ($16,858,499) 9 Birtcher/Charlesbank Office Portfolio GCCFC 2005-GG3 A2 in foreclosure CA Office CMBS loans represent term prepayment risk. GCCFC 2005-GG3 A2 CA Office $45,371,159 n/aGSMS ($6,071,159) 10 Four Falls $39,300,000 2005-GG4 A2 PA Office significant prepayment and default risk The loan onA2 Three Columbus Circle categorized as delinquent until it was ($2,200,000) GSMS 2005-GG4 PA Office loan was $42,200,000 $40,000,000 4/7/11

Total
Deal

Reported DSCR

Loan Balance

Target Bond

$746,254,958
State

.25 to .49

.50 to .74

.75 to .99

0 to .24

sold (in defiance of the borrowers requested workout). WBCMT 2006-C23 currently has eleven delinquent loans which represent $166.6 million in loan exposure.4 Unfortunately for bondholders, the properties are valued at $133.1 million, a deficit to their loan balances (Figure 5). However, since the balances are allocated on an individual loan basis, two of the properties are valued greater than their loan exposure. Those deals still have equity and a chance of refinancing. The special servicer estimates a sale price at 90% of value. A payment of 90% of the approximate value of $133.1 million would first repay servicer advances of $7.0 million and then be applied towards principal repayment of $112.2 million. In total, the delinquent loans could result in a $53.8 million loss, which would write down the junior tranches. By analyzing the REO and delinquent loans, it is possible to estimate a total prepayment risk of nearly $170 million and potential losses to junior tranches of $94.6 million (Table 1, Figure 7). A write down of $94.6 million to junior tranches would completely wipe out the S, Q, P, O, and N tranches, and 93% of the M tranche. Holders of those tranches would benefit if these loans were extended or if recoveries exceeded the
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to investors (Tables 6 and 7). The top ten

largest loans in foreclosure represent $130 million in loss risk and uncertainty to their CMBS bondholders. If these losses are fully realized, it would generate a 19.5% loss on the $663 million in loan exposure. Once risky loans are identified, how does one evaluate them and assess potential losses or prepayments?
4

Moodys CMBS

standards re-underwrite existing CMBS in

The eleven delinquent loans in this deal have a total principal balance of $159.6 million, but when servicer advances are included there is an additional $7.0 million in loan exposure. 5 This excludes the loan on the property at 620 Sixth Avenue, which has been recapitalized, according to press reports.

Total

$746,254,958

$115,939,623

$631,134,724

$34,864,221

$23,970,097

$247,049,267

$325,251,138

Deal

Target Bond

State

Property Type

Loss Risk is the REO Loan Balance subtracted from Most Recent Property Rank Value Loan Name

Loans

WBCMT 2006-C28 JPMCC 2005-CB13 GSMS 2006-GG8 CWCI 2006-C1 GCCFC 2005-GG5 BACM 2005-3 CSFB 2001-CKN5 CGCMT 2007-C6 BACM 2006-4 GSMS 2005-GG4

$318,034,342 $180,900,000 $179,805,189 $110,753,000 $107,753,000 $96,500,000 $89,930,399 $87,702,073 $74,127,123 $71,022,826

Deal Name Foreclosure Loan CMBS deals with largest REO loss risk Balance Deal Name Loss Risk Ranking JPMCC 2005-CB13 $167,946,611 WBCMT 2006-C28 ($72,044,342) 1 BACM 2006-5 $127,777,001 JPMCC 2005-CB13 ($68,260,000) 2 JPMCC 2004-CBX $88,000,000 GSMS 2006-GG8 ($65,405,189) 3 GSMS $83,125,000 CWCI 2005-GG4 2006-C1 ($56,030,399) 4 GMACC 2006-C1 $70,988,785 GCCFC 2005-GG5 ($43,027,073) 5 BACM 2005-3 ($38,785,404) 6 GCCFC 2005-GG3 $67,727,758 CSFB 2001-CKN5 ($37,875,000) 7 CSMC 2007-C1 $64,000,000 CGCMT 2007-C6 ($22,703,000) 8 LBFRC 2006-LLFA $57,361,673 BACM 2006-4 ($22,701,636) 9 BACM 2006-1 $55,000,000 GSMS 2005-GG4 ($19,763,991) 10 BACM 2005-3 $50,923,880

Both REO and delinquent loans also

Balance

$153,000,000 $112,640,000 $65,650,000 $42,700,000 $37,825,000 $128,000,000 $50,400,000 $42,000,000 $110,000,000 $27,050,000

44

25

$113,120,000 $91,500,000 $50,300,000 $397,650,000 $35,000,000 $46,850,000 $85,100,000 $32,200,000 $39,300,000 $40,000,000 1/13/11 12/14/10 12/20/10 7/1/05 3/24/10 n/a 1/19/11 3/1/11 n/a 4/7/11 ($14,657,001) ($15,530,785) ($37,700,000) n/a ($29,000,000) ($9,250,000) n/a ($16,858,499) ($6,071,159) ($2,200,000)

DealaName REO Loan Ranking present serious prepayment risk for senior WBCMT 2006-C28 $318,034,342 1 the next 12 months, it would completely JPMCC 2005-CB13 $180,900,000 2 prepay the A-PB class and also prepay a GSMS 2006-GG8 $179,805,189 3 portion of the A-4 tranche, which are CWCI 2006-C1 $110,753,000 4 the GCCFC 2005-GG5 $107,753,000 5 next level of senior bonds. Investors who had BACM 2005-3 $96,500,000 6 recently purchased these bonds expecting CSFB 2001-CKN5 $89,930,399 7 stable yield would be disappointed CGCMT 2007-C6 $87,702,073 with 8 the quick 2006-4 return of their principal and a lack BACM $74,127,123 9 of GSMS 2005-GG4 $71,022,826 10 interest income.

tranches. If these loans were prepaid within

JPM

BA

JPM

Foreclosure Loan Balance

GS

Value Date

Value Date Loss Risk

2/3/2011 n/a n/a 10/17/2011 8/19/2011 6/1/2001 12/16/2010 5/20/2011 9/27/2010 6/1/2011 ($37,000,000) ($68,260,000) ($24,359,189) ($41,865,377) ($32,175,000) n/a ($3,383,787) ($9,303,123) n/a ($23,450,000)

GM

$127,777,001

$167,946,611

$50,923,880

$55,000,000

$57,361,673

$64,000,000

$67,727,758

$70,988,785

$83,125,000

$88,000,000

GC

CS

LB

BA

BA

Loss Risk

3 Ariel Preferred Retail Portfolio GSMS 2006-GG8 A2 Various Retail $90,009,189 $84,565,377 4 Moreno Valley Mall CGCMT 2007-C6 A1 CA Retail 5 FRI Portfolio BACM 2005-3 A2 Various Office $70,000,000 PREDICTING CMBS PREPAYMENTS AND DEFAULTS 6 Highland Mall JPMCC 2002-CIB4 A3 TX Retail $61,104,416 7 Windsor/RECP Hotel Portfolio GCCFC 2005-GG5 A2 CA Hotel $53,783,787 8 55 Park Place BACM 2006-4 A3A GA Office $51,303,123 Table 6: WBCMT 2007-WHL8 A1 Various Hotel $51,000,000 9 Four Seasons Nevis 10 Tower Place 200 GSMS 2006-GG8 A2 GA Office $50,500,000 Largest loans in foreclosure and loss risk Rank 1 2 3 4 5 6 7 8 9 10 Loan Name Trinity Hotel Portfolio The Shore Club Continental Plaza DDR/Macquarie Mervyns Portfolio 717 North Harwood Street Investcorp Porfolio Fairmont Sonoma Mission Inn & Spa Novo Nordisk Headquarters Birtcher/Charlesbank Office Portfolio Four Falls Deal BACM 2006-5 JPMCC 2005-CB13 JPMCC 2004-CBX GMACC 2006-C1 CSMC 2007-C1 JPMCC 2005-CB13 BACM 2006-1 CGCMT 2005-C3 GCCFC 2005-GG3 GSMS 2005-GG4 Target Bond A2 A2FL A5 A3 A1A A2FL A2 A2 A2 A2 State Various FL NJ Various TX PA CA NJ CA PA Property Type Hotel Hotel Office Retail Office Industrial Hotel Office Office Office Current Trust Balance $127,777,001 $107,030,785 $88,000,000 $70,988,785 $64,000,000 $56,100,000 $55,000,000 $49,058,499 $45,371,159 $42,200,000

$65,650,000 $42,700,000 $37,825,000 $128,000,000 $50,400,000 $42,000,000 $110,000,000 $27,050,000 Recent Value $113,120,000 $91,500,000 $50,300,000 $397,650,000 $35,000,000 $46,850,000 $85,100,000 $32,200,000 $39,300,000 $40,000,000

n/a ($24,359,189) 10/17/2011 ($41,865,377) 8/19/2011 ($32,175,000) SPRING 2012 6/1/2001 n/a 12/16/2010 ($3,383,787) 5/20/2011 ($9,303,123) 9/27/2010 n/a 6/1/2011 ($23,450,000) Value Date 1/13/11 12/14/10 12/20/10 7/1/05 3/24/10 n/a 1/19/11 3/1/11 n/a 4/7/11 Loss Risk ($14,657,001) ($15,530,785) ($37,700,000) n/a ($29,000,000) ($9,250,000) n/a ($16,858,499) ($6,071,159) ($2,200,000)

Figure 6:
Visualization of WBCMT 2006-C23 tranches as of September 2011

Figure 7:
WBCMT 2006-C23 junior tranches as of September 2011

an effort to estimate the ability of immediate refinancing proceeds to payoff the existing loan balances.6 If these estimated loan proceeds are less than the loan balance, then a loss to the CMBS trust is expected. If the loan proceeds are greater than the loan balance, then there would not be a loss to trust. Moodys stated method works backwards from current NOI and uses the lesser amount of proceeds resulting from either a DSCR of 1.25 (1.50 for hotels) or an LTV of 65% (75% for hotels) test.7 Under this method, an office property with $5 million in NOI would qualify for a $43.2 million refinancing using the LTV approach (with $4 million in debt service).8 Applying Moodys methodology to the 44 loans in WBCMT 2006-C23 with DSCRs below 1.0 results in an estimated loss of $631.1 million. This extreme loss would wipe out all of the $524 million junior tranches that provide credit support for the deal, and the A-J tranche would take a $107 million loss (Figure 7). In addition, senior bonds would take in $116 million in prepayments, further eroding the yield and value of senior bonds. While the Moodys loan analysis seems to err on conservative side by applying
Published by Moodys in US CMBS and CRE CDO Surveillance Review Q2 2010 (August 19, 2010). 7 Moodys uses an interest-only loan originated at a 9.25% interest rate, while the LTV approach uses an 8.0% cap rate. DSCR Proceeds = (NOI/DSCR)/9.25%. LTV Proceeds = (NOI/8.0%) * LTV. 8 The proceeds of $43,243,243 obtained by the DSCR method are less than $46,875,00 obtained using a 8.0% cap rate and 75% LTV.
6

Senior tranches (first pay) are at the bottom, junior tranches (first loss) are at the top.

Tranches N through S with a total balance of $75 million would be wiped out if the REO and delinquent loans took the $94.6 million losses explained herein. Tranche M would lose 93% of its value.

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PREDICTING CMBS PREPAYMENTS AND DEFAULTS

SPRING 2012

Table 7:
CMBS deals with largest foreclosure loan balances

The loans with DSCRs under 1.0 are severely troubled, and they very well may be the next crop of bad loans that the special servicer will be forced to workout. To gain a better understanding of possible outcomes, further analysis of the 44 loans could include special servicer reports, the opinions of local brokers and local market data to assess property conditions. A more precise outcome could then be estimated and the prepayment expectations could be entered into pricing models to understand the impact on junior and senior CMBS
44 7 3 9 25

loans again. As a result of the aggressive workouts, Non-CMBS lenders also carry much higher REO balances compared to CMBS, the RCA statement concluded.

Deal Name JPMCC 2005-CB13 BACM 2006-5 JPMCC 2004-CBX GSMS 2005-GG4 GMACC 2006-C1 GCCFC 2005-GG3 CSMC 2007-C1 LBFRC 2006-LLFA BACM 2006-1 BACM 2005-3

ng

Foreclosure Loan Balance $167,946,611 $127,777,001 $88,000,000 $83,125,000 $70,988,785 $67,727,758 $64,000,000 $57,361,673 $55,000,000 $50,923,880

Conclusion
This article provides a real market example of how a distressed commercial mortgage resulted in a significant prepayment to senior CMBS investors. It also demonstrates how to analyze CMBS loan data using both special servicer reports and ratings agency methodologies to understand the impact on CMBS tranches. The techniques described in this white paper can be applied in numerous insightful and profitable ways. Investors can compare different CMBS issuances and tranches to determine which offer the best value for purchases on the secondary market. In addition, current owners of CMBS can perform a thorough credit analysis on their portfolios to make hold as well as sell decisions.

tranches.
Loans

The data shows that special servicers have

$34,864,221 $23,970,097 $631,134,724 $746,254,958 $115,939,623 $247,049,267 $32,947,218 $279,996,485 $325,251,138 $404,115,453 $78,864,315

been less aggressive in addressing distress a high interest rate, the derived loan Loss Current Trust Recent Value Value Date Risk Balance amount is based on an interest-only loan. than non-CMBS lenders. According to Real increased $7.7 billion through September rate would result in substantially lower $90,009,189 $65,650,000 n/a ($24,359,189) 2011. In comparison, non-CMBS lenders funds available $42,700,000 to borrowers. However, ($41,865,377) $84,565,377 10/17/2011
$543,958 $34,588,791 $61,104,416 $128,000,000 6/1/2001 the same amount. The comparison terms competitive with Fannie Mae or about n/a $53,783,787 $50,400,000 12/16/2010 ($3,383,787) also highlights the significant differences Freddie Mac financing can obtain greater ($9,303,123) $51,303,123 $42,000,000 5/20/2011 loan proceeds $110,000,000 than Moodys 9/27/2010 estimates. between $51,000,000 n/a CMBS and non-CMBS lenders $50,500,000 6/1/2011 ($23,450,000) in dealing with roughly the same amount For example, on$27,050,000 a loan with multifamily Est. Prepayment Loan Balance $70,000,000 properties $37,825,000 have reduced their distress balances by multifamily able 8/19/2011 to obtain ($32,175,000) $3,584,132 $27,554,229 $180,900,000 $112,640,000 n/a ($68,260,000) Est. Loss $190,000,000 $153,000,000 2/3/2011 Capital Analytics (RCA), CMBS distress An amortizing loan with the same interest ($37,000,000)

rty

collateral at 6.5% interest rate and a 25-year

Current Trust Recent Value Value Date Loss Risk amortization period, loan proceeds would said in a press release. According to RCA, Balance

of distressed commercial property, RCA

Non-CMBS lenders have been more be 14% greater $113,120,000 than Moodys estimates. $127,777,001 1/13/11 ($14,657,001)
$107,030,785 these $91,500,000 12/14/10 aggressive at working out problem loans Furthermore, broad brushstrokes do ($15,530,785) $88,000,000 $50,300,000 12/20/10 ($37,700,000) and have relied far less on modifications or $70,988,785 $397,650,000 7/1/05 n/a extensions, which risk becoming problem the$64,000,000 property. $35,000,000 3/24/10 ($29,000,000) $56,100,000 $46,850,000 n/a ($9,250,000) $55,000,000 $85,100,000 1/19/11 n/a Bibliography $49,058,499 $32,200,000 3/1/11 ($16,858,499) CTSLink, CTSLink. N.p., n.d. Web. http://www.ctslink.com. $39,300,000 n/a ($6,071,159) $45,371,159 $42,200,000 $40,000,000 4/7/11 ($2,200,000) Find a Securitization, CMBS.com - Providing Standardized Tools for the CMBS Industry.

This research report is published by the Steven L. Newman Real Estate Institute, Baruch College, CUNY. The Newman Real Estate Institute gratefully acknowledges the support of the sponsors who make possible our efforts to promote critical thinking on topical issues for the real estate industry. The views expressed in the research report are those of the authors and not necessarily those of Baruch College, City University of New York, or any of its affiliated organizations, foundations, and sponsors. Please address inquiries to Jack S. Nyman, Director, at:

not provide a nuanced appraisal specific to

al

Reported DSCR

.25 to .49

.50 to .74

.75 to .99

0 to .24

N.p., n.d. Web. http://www.cmbs.com/searchresults.aspx?showall=1.

Jacob, David P., Manzi, James M. and Fabozzi, Frank J., Handbook of Mortgage Backed Securities, Chapter 50, The Impact of Structuring on CMBS Bond Class Performance. Moinian misses payments on 1775 Bway . Crains New York Business, June 2, 2010: http://www.crainsnewyork.com/article/20100602/REAL_ESTATE/100609962. Moinian misses payment on third property . Crains New York Business, November 11, 2009: http://www.crainsnewyork.com/article/20091113/FREE/911139985. Securitization, CMBS.com - Providing Standardized Tools for the CMBS Industry. N.p., n.d. Web. http://www.cmbs.com/securitization.aspx?dealsecuritizationid=1399. Tussle over 1775 Broadway goes down to wire . Crains New York Business, December 6, 2010: http://www.crainsnewyork.com/article/20101206/REAL_ESTATE/101209910. US CMBS and CRE CDO Surveillance Review Q2 2010, Moodys, August 19, 2010.
P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010 www.baruch.cuny.edu/realestate 8

Total

Baruch College, CUNY 137 East 22nd Street Box C-0120 New York, NY 10010 Tel: 646.660.6950 Fax: 646.660.6951 www.baruch.cuny.edu/realestate

Mitchel B. Wallerstein, President, Baruch College William Newman, Founding Chair Richard Pergolis, Co-Chair Jack S. Nyman, Director Emily Grace, Associate Director of Research