Despite recent high profile CMBS prepayments, such as White Tower 2006-1 and 2006-2, market sources said 2007 should see the level of prepayments fall on the back of modest interest rate hikes and a slowdown in property value increases.
Over the past six months, the market has seen a slight decrease in prepayments. The interest rate increases seen over the past year have raised the cost of refinancing for borrowers and limited the chances of reduced interest rates on loans by refinancing. Borrowers who were looking to reduce their financing costs have done so by now, and according to Standard & Poor's, they are starting to prefer existing loan agreements because they would not necessarily be finding better terms on the market now. "Prepayments are another concern in CMBS transactions, but looking at all repayments, we feel rates should stabilize because the economic incentives to repay are reduced," said Hans Vrensen, head of the Barclays Capital European securitization research team.
Dresdner Kleinwort Wasserstein analysts expect prepayment rates of more recent vintages to fall on the back of declining property price appreciation. According to S&P, the repayment rates for CMBS vintages of 2003 and 2004 are much higher, and, in some instances, nearly twice as high as for older vintages. The pace of prepayments for both the 2003 and 2004 vintages slowed down again over the last quarter. Barclays' analysts reported that transactions issued in 2005 have repaid at half the rate of those issued in 2004. This is a departure from the general trend of increasing repayment rates across the successive 1998 to 2004 vintages. Between transaction types, multiborrower deals show higher, less volatile rates of repayment than single-borrower or synthetic transactions.
"We also expect cap rates to remain range-bound this year; potential price appreciation will be driven by rental growth," Dresdner analysts said in a structured credit report published last week. "This should stop the refinancing opportunities of highly leveraged borrowers and slow their prepayments."
In 2006, 86% of upgrades were due to prepayments, said S&P. Barclays' Vrensen said that despite relatively good short-term fundamentals, an increase in performance-related issues was expected starting with the first note-level default in 2007.
"These might come from deals like ELoC 8 or at the resolution at legal final maturity of the Hoteloc transaction, which has been lingering after multiple downgrades over the years," he said. "Some of these loan level defaults could result in the first-ever rated note-level default, during 2007."
Hoteloc is a 2003 single-loan CMBS transaction, backed by a hotel portfolio, in which the underlying loan was not repaid at the expected maturity date of May 2005. At the time, S&P said it did not consider the fact that the ratings on the notes were unaffected by the loan default. This was because its ratings were based on the timely payment of interest and principal until the deal reached its legal final maturity, which, in this case, was May 2007. As a result, the special servicer, Capmark Services U.K. Ltd., implemented a borrower-assisted workout strategy that culminated in a potential sale of the assets, S&P analysts said.
In September 2006, S&P placed the notes on CreditWatch with negative implications because of concerns that Capmark Services U.K. would be unable to sell the assets before the legal final maturity, which meant the notes would miss their scheduled repayment date. Capmark Services U.K. announced that a sale was imminent, although it has subsequently been delayed. As a consequence, the notes remain on CreditWatch negative.
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