Commercial Real Estate Heads South

Simmering beneath the surface and unbeknownst to most is a pronounced deterioration in commercial real estate. The evidence is can be seen in widening spreads in the tranches of Commercial Mortgage Backed Credit Default Swap Benchmark CMBX Indices.

Commercial real estate problems are in addition to massive problems in the guarantee business as evidenced by the huge widening of spreads on the two largest bond guarantee companies, Ambac Financial Group (ABK) and MBIA Inc (MBI).

For more on the systemic risk in the bond guarantee business, please see a Downward Spiral of Deep Junk.

Rising spreads represent a greater chance of default. In commercial real estate, most spreads are now wider than they were in the peak of the mid-summer credit crunch. This indicates two things:

• Problems that previously affected only residential real estate have now spread in a big way to commercial real estate.
• In spite of the big stock market rally off the summer lows, underlying credit conditions are deteriorating rapidly.

Here are a few charts in support of the above two points:

(click on any of the following charts to see a sharper image)

CMBX-NA-AAA 1



CMBX-NA-AA 3


CMBX-NA-A 3


CMBX-NA-BBB 3



CMBX-NA-BBB- 1


CMBX-NA-BB 3



CMBS Ratings

• “AAA” means a rating of AAA (if rated by Fitch or S&P) or Aaa (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
• “AA” means a rating of AA (if rated by Fitch or S&P) or Aa2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
• “A” means a rating of A (if rated by Fitch or S&P) or A2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
• “BBB” means a rating of BBB (if rated by Fitch or S&P) or Baa2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
• “BBB-” means a rating of BBB- (if rated by Fitch or S&P) or Baa3 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
• “BB” means a rating of BB (if rated by Fitch or S&P) or Ba2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.

(click on any of the following charts to see a sharper image)

How Tranches Work


CMBS Issuance


The above chart shows $508.4 Billion in CMBS issuance since 2005. Think that commercial real estate is marked to market? I don't and neither do credit default swaps.

CMBS Who Is At Risk?



CMBS Top Loan Contributors



The previous four charts are courtesy of CMBS.ORG.

While all eyes have been on residential real estate problems, commercial real estate appears poised for a significant turn south. A tip of the hat to Professor Mark Bloudek for mentioning the CMBX index in a Minyanville Buzz & Banter last week.

Comments

[johnthebear:]

Take a look at "National Real Estate Investor", Oct. 07, page 28 for something that will really shake you up. 59% of commercial loans in first half of 07 were interest only and LTV ratio exceeded 105%. There are many charts and tables that document the danger in the commercial market for CDO's. Your charts and tables above do a good job of outlinging the size of the risk and who carries most in this country. The thing that is most dangerious and not discussed in our financial press is the risk in German, English, Spanish banks that are just as bad as our worst. England Northern Rock is the tip of the iceburg.

2007 Nov 08 05:24 AM

[Tom B:]

Help me out-- it looks like BAC, JPM-- mainstream banks-- have more exposure, by a lot than the notorious Countrywide finance.

Ouch. Should have sold.

2007 Nov 08 09:34 AM

[Tom B:]

Help me out-- it looks like BAC, JPM-- mainstream banks-- have more exposure, by a lot than the notorious Countrywide finance.

Ouch. Should have sold.

2007 Nov 08 09:34 AM

[User 30073:]

It is not clear to me an average non-professional what the spread is between. Clarification would be appreciated

2007 Nov 08 07:29 PM

[jstiel:]

In my opinion, the premise of this post is not valid.

Widening spreads are not evidence of deterioration in the commercial real estate markets. It only means that financing is getting more expensive. Like the corporate bond market and the stock market, CMBS is the market for the debt, not for real estate itself.

The above list of contributors does not reflect specific exposure. It shows volume of origination and sale into CMBS from 2006. None of the above info shows current exposure of specific institutions.

I haven't seen the NREI chart, but I'm sure it shows stressed, not appraised LTVs. You can look at the actual appraised LTVs by reviewing the original SEC filings of each deal. You will find few if any LTVs in excess of 80% and the average loan to appraised values of each deal (pool) are less than 80%

The problems of the bond guarantors you reference are not caused by CMBS exposure.

Spreads are usually quoted over Treasuries or Swaps.

Increased spreads do not increase the chance of default in the near term because these are mostly 10-year fixed deals. Increased spreads could increase refinance risk at maturity, but most loans done 10 years ago are coming off higher rate notes and usually have benefited from increases in rents and amortization.

Problems that have affected residential generally do not directly affect commercial. In the commercial world, there are no no/doc, low/doc loans. The commercial market did not experience the overbuilding that the availability of subprime spurred in residential.

CMBS defaults are .3% vs 16% in subprime.

I'm not saying that CRE is not negatively impacted by the condition of the bond market and the economy, but it is nowhere near as severe as the subprime mess and any suggestion that it is is not supported by the facts I am aware of.

2007 Nov 17 12:19 PM