September saw a rare level of loss in the commercial real estate market, according to the Barron's/John B. Levy & Co. National Mortgage Survey. The culprit: terrorism. Twenty-two buildings in and around the World Trade Center were destroyed or damaged, which included 29 million sq. ft. of office space, according to reports from Merrill Lynch and Grubb & Ellis. More than 18 million sq. ft. is covered by five separate commercial mortgage-backed securities (CMBS) issues, totaling nearly $2.7 billion.
The WTC complex was covered by two securitizations. A $563 million securitization offered in August by GMAC Commercial Mortgage covers buildings 1, 2, 4 and 5, which were destroyed in the Sept. 11 terrorist attacks. In late September, the Fitch Commercial Mortgage Group affirmed the ratings on all the issue's classes. The rating agency reasoned that insurance proceeds are adequate to repay principal and that bondholders' consent would be needed before rebuilding.
But if the bonds are paid off, holders of the interest-only (IO) strips, totaling $15 million, will suffer significant losses. IO holders include both Lend Lease and GMAC. Since GMAC is also the master servicer for the securities, it raises a potential conflict of interest. As master servicer, its primary obligation is to the bondholders. At the same time, a payment in full to the bondholders would result in substantial losses to GMAC as an IO strip holder.
World Trade Center 7, the 47-floor tower that fell late on Sept. 11, was separately mortgaged under a $383 million CMBS issue led by Bank of America less than 30 days before the attack. The 2 million sq. ft. building was substantially leased to Citicorp. Although September's payment was received, Moody's Investors Service will review the issue for possible downgrades. The building is insured, but Moody's believes the tenant will have the right to vacate the lease, exposing the bondholders to significant risk.
Insurance issues take center stage
Clearly, investors and rating agencies on both transactions are focusing on the potential pools of insurance proceeds to rebuild and reoccupy the buildings. Yet before Sept. 11, insurance was thought to be such a “so what?” issue that the presale reports issued by the rating agencies never even mentioned it.
For bondholders, there's a vast difference between a collapsed building and one that can be restored to service. On two 1996 Merrill Lynch large-loan securitizations covering buildings 2 and 4 of the World Financial Center, located just west of WTC, Moody's has reaffirmed the existing ratings for the $1.3 billion of affected bonds. According to Moody's, Merrill Lynch has indicated that rental payments on its space will continue as scheduled. Thus, distributions to the bondholder will be unaffected.
Meanwhile, the damaged 1 Liberty Plaza, a 2.1 million sq. ft. tower east of the WTC, was financed by a $432 million securitization led by Goldman Sachs. Standard & Poor's, which rated the transaction, indicates that it does not believe CMBS ratings on this securitization will be affected either.
Interest-rate floors in effect
Despite the losses, the commercial mortgage business already is trying to return to normal. The most noticeable change on the institutional side was the widespread use of interest-rate floors. Lenders argued that rates on Treasuries had fallen so precipitously that they were unwilling to take on real estate risk for much less than 7%. In general, lenders imposed floors on five-year mortgages in the 6.50% to 6.75% range, which was a whopping 2.65% to 2.90% over the five-year Treasury. Meanwhile, floors for 10-year loans were in the 6.75% to 7% range, with the lower rates reserved for low-leverage transactions and multifamily loans.
On the CMBS side, initially the September offering calendar had looked to be huge, with some $8 billion scheduled to come to market, on top of more than $7 billion securitized in August. All that changed on Sept. 11. Just two transactions, together worth $1.6 billion, were brought to the market. Some deals were postponed, while other deals involving property types suffering from declining business, such as hotels, may not be back for quite a while.
John B. Levy is president of John B. Levy & Co. Inc. (www.jblevyco.com), Richmond, Va. © Dow Jones & Co. Inc.
Barron's/John B. Levy & Co. National Mortgage Survey
|To 10-year U.S. Treasuries|
|AAA||128 - 130||125 - 126|
|AA||148 - 150||140 - 142|
|A||168 - 173||155 - 157|
|BBB||228 - 233||210 - 215|
|BB||550 - 575||520 - 540|
|Term of Loan||Prime Mtge. |
|Prime Mtge. |
|5 years||6.50 - 6.75||6.62||6.45 - 6.50|
|7 years||6.75 - 7.00||6.87||6.83 - 6.88|
|10 years||6.93 - 7.08||6.98||6.93 - 6.98|
|For loans of $5 million and up, on amortization schedules of 25-30 years, that can be funded in 60-120 days, with 0-1 point.|