Single-Asset, Single-Loan CMBS is Back
Securitization of single, large loans has slowed this year, in part because of competition from insurance companies and banks to finance better quality properties that would typically back these deals. More recently large loans that have tapped the securitization market have done so via conduit deals, where the loan is split into multiple parri passu notes.
However, two recent deals, Deutsche Bank’s $734.6 million GRACE 2014-GRCE and Citigroup’s $1.45 billion Commercial Mortgage Trust 2014-388G, signal the return of single asset CMBS backed by tier one office properties.
Deutsche Bank’s deal is backed by the Grace Building and Citigroup’s deal is backed by 388 Greenwich Street — both buildings are office properties located in Midtown Manhattan.
Single-asset transactions are inherently riskier than conduits backed by multiple loans because of the lack of diversification; performance risk is concentrated in just one commercial property. (Sometimes a transaction contains more than one loan, but in these cases the loans are not cross-defaulted; a default on one loan does not triggers a default on another loan in the pool.) This means that single-asset CMBS are generally less liquid in the secondary market, and so tend to have a smaller buyer base.
The collateral backing many large commercial loans securitized over the past couple of years is also relatively risky. Unlike office or industrial buildings, where tenants sign leases for 20 years or more, or even apartment buildings, where leases may be no longer than one year, vacancy rates at hotels fluctuate daily. The cost of a hotel room can also change daily, depending on demand. “These assets are less appealing to insurers and banks because of their elevated volatility of cash flows,” said Keerthi Raghavan, a CMBS analyst at Barclays.
Until recently, tier one office properties didn’t show up in many CMBS, either conduits or single-asset deals. These properties tend to be financed by insurance companies. But falling interest rates have made funding in the securitization market much more attractive.
“It is possible that improved fundamentals and lower interest rates are collectively shifting more buyers and thus more demand to single asset/single borrower bonds,” said Todd Swearingen, a spokesperson at Interactive Data.
Barclays also pins the return of tier one, single asset CMBS to the declinein Treasury yields, which makes CMBS look more attractive relative to other forms of funding. For example, the week ending May 30 (the week the GRACE transaction priced), yields on 10-year Treasuries dipped below 2.5%, levels last seen in October 2013. “The sharp rate rally over the past few months has made CMBS funding competitive versus coupons offered by insurer/banks,” Raghavan said. “This has boosted single-borrower issuance volumes and improved underlying collateral."
The tier-one office transactions that priced in May and June also came in at levels comparable to conduit tranches. For example, in May, Deutsche Bank sold $520.6 million of class A notes, rated triple-A at a spread of swaps plus 75 basis points. By comparison, that same month the bank that month sold the longer dated, 10-year, triple-A notes from its COMM 2014-UBS3 trust at swaps plus 86 basis points.
The $74 million of double-A minus rated, class B notes sold from the GRACE transaction priced at a spread of swaps plus 90 basis points. The double-B minus rated class F notes from the Grace transaction, sized at $115 million, priced at swaps plus 265 basis points and the single-B rated G notes sized at $25 million priced at swaps plus 315 basis points.
The Grace Building’s largest tenant is Home Box Office, which leases 20.7% of the net rentable area. HBO’s guarantor, Time Warner, reportedly plans to consolidate operations from numerous locations throughout New York City into the Hudson Yards project around the time HBO’s lease expires, which could mean that HBO will not renew its lease.
However, the loan requires a 24-month notice under the lease terms, which analysts said should provide ample time to find suitable replacement tenants if the HBO opts to leave.
The Citigroup Commercial Mortgage Trust 2014-388G is secured by the fee interest in 388 and 390 Greenwich Street, two adjoined class A office buildings comprising 2.6 million square feet in the TriBeCa neighborhood, according to a presale report published by Standard & Poor’s. The buildings are 100% leased by Citigroup Technology and guaranteed by its parent, Citigroup.
Citigroup has a long-term triple net lease through December 2035, more than 14 years after the loan comes due.
Issuers priced $595 million of class A, triple-A rated, four-year notes at a spread of Libor plus 82 basis points. The $218.5 million, four-year, double-A minus rated notes priced at Libor plus 112 basis points. The double-B minus, four-year class E notes priced at Libor plus 215 basis points and the single-B plus F notes priced at Libor plus 315 basis points.
This revival of tier one office properties is a reversal from the trend that the banks saw beginning in June 2013, when rates spiked, making CMBS funding for higher quality/stronger credit assets less competitive compared with funding from insurance companies and banks.
Last year “when rates were near all-time lows, that supply did anecdotally dry up as the market sold off into the summer,” Swearingen said.
Higher quality collateral doesn’t necessarily translate into less risk, however. Fitch Ratings is concerned that the subordinated tranches of some recent single-asset CMBS do not warrant the ratings assigned by some of its rival agencies.
The five deals that the rating agency questioned are all backed by hotels, albeit hotels that the rating agency considers to be of higher quality than the “average quality” hotels that backed many single-asset CMBS in 2013. Specifically, Fitch is concerned that ratings of BBB−’ through B’ on a substantial number of 2014 large loan transactions are not warranted given the significant amount of debt at those ratings. Fitch’s wariness is further reinforced by the amounts of additional debt, subordinate to the first mortgage, that raise leverage on the property and sponsor even further.
In a June 9 report, the rating agency reviewed four transactions that it declined to rate because it felt that the levels of debt and their assigned ratings of BBB−’ and below were not warranted: the Wells Fargo Commercial Mortgage Trust 2014-TISH; CGBAM Commercial Mortgage Trust 2014-HD; GS Mortgage Securities Corp. Trust 2014-NEW; and GP Portfolio Trust 2014-GPP.
Fitch expects that these transactions will perform over their terms; the concern is the refinancing risk when the loans mature. “We could expect to be in a higher interest rate environment and if that were to occur then you could expect to see downgrades to those transactions,” said managing director Huxley Somerville.
Fitch reserved its strongest criticism for the ratings assigned to a deak backed by five Kyo-Ya hotel properties in Hawaii and California. Deutsche Bank is the sponsor of the $1.4 billion deal, COMM 2014-KYO which is a refinancing of similar deal completed in January 2013.
The transaction, which was being marketed as ASR was going to press, would add $300 million in debt, while removing one of the weaker performing properties — the 1,142-room Sheraton Princess Kaiulani — as collateral. “The increase in total debt and the reduction in supporting collateral should give investors pause,” Fitch stated in a separate report. It noted that both transactions, the properties being used as collateral also secure additional, mezzanine debt not included inteh securitization trust.
The previous Kyo-Ya financing, GSMS 2013 KYO, totaled $1.1 billion or $213,178 per room. In comparison, the current COMM 2014-KYO transaction equates to $348,606 of debt per room.
Fitch, which initially reviewed but ultimately did not rate COMM 2014-KYO, said that the high leverage, “combined with a reduced collateral pool compared to last year’s transaction, a management transition, and potentially peak performance” would have resulted in lower subordinate bond ratings by than those assigned by Morningstar and S&P.
Morningstar assigned a preliminary BBB+’ rating to $90 million of class D notes; BBB-’ to $98 million of class E notes; BB-’ to $286 million of class F notes and B+’ to $40 million of class G notes. S&P rated the subordinated notes at equivalent levels.
Fitch said that it would have not rated the class E notes higher than BB-,’ three notches lower than Morningstar.