NorthStar Realty Finance Corp. priced its $351 million CMBS transaction, 2012-1, at a weighted average coupon of LIBOR + 1.63%, amid concerns that the structure's triple-A bond lacks sufficient credit enhancement, according to Fitch Ratings.
Fitch said today in a comment that the deal's most senior class (the class A notes) are structured with 56.5% credit enhancement, which would have likely achieve a rating no higher than ‘Asf’, which is two full rating categories below where the class is expected to be rated by Standard & Poor's and Moody's Investors Service.
Fitch said it was concerned about refinance risk and the high likelihood of default at maturity, especially in a higher interest rate environment. The default probability for the collateral in the CMBS pool exceeds any that Fitch has seen to date in CMBS 2.0.
The transaction is collateralized by commercial real estate first mortgages originated by NorthStar and one of its sponsored non-traded REITs, NorthStar Real Estate Income Trust, according to a NorthStar press release issued today.
A total of $228 million of investment grade bonds will be issued, representing an advance rate of approximately 65%. NorthStar and NorthStar Income will retain an equity interest in the CMBS transaction equal to $54 million and $69 million, respectively.
Fitch said that the loans in the collateral pool are subject to interest rate risk given that they are not structured with an interest rate cap. For instance, Buena Park, the largest loan in the pool (20.8%), is an anchored retail center located in Buena Park, which could experience substantial losses or face significant challenges refinancing in a higher interest rate environment.
Another example is the Cranbrook Multifamily Portfolio (5.7%), which Fitch said is also subject to interest rate risk given that it does not have an interest rate cap and has additional debt in the form of a mezzanine loan. If the borrower’s business plan is not successful in renovating and stabilizing the property, the loan could be subject to sizeable losses and have substantial difficulty refinancing in a higher interest rate environment, explained the Fitch report.
Concentration risk also subjects the pool to a high potential for adverse selection. "It is easy to envision a scenario where a few of the better performing loans pay off and the remaining loans are sub-performing or defaulted," said Fitch analysts in the report. "The deal could be heavily dependent on the servicer’s ability to work out loans to realize value recovery to pay down the bonds."
Fitch also noted that the bonds are susceptible to interest shortfalls if the servicer experienced significant costs to work out the loans and financed the costs and other workout fees through to the trust.
The bonds are offered in the Rule 144A market. Fitch said in its commentary today that it was engaged by the issuer to provide feedback on the CMBS deal, but that it was not ultimately selected to rate the deal due to its more conservative credit stance.