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Dissecting JPM CMBS offering
Today Fitch issued last months data regarding delinquency rate in CMBS securities; and as you might have guessed; it is far from rosy.
Delinquencies on loans in commercial mortgage-backed securities continued to increase last month, mostly owing to a $1 billion net increase in overdue office loans. CMBS delinquency rates have continued to rise this year. Commercial-property owners got increasingly behind on their mortgages last year as occupancy rates and rents fell, driving property values down from highs during the real-estate bubble. Fitch said overall CMBS delinquencies rose to 7.97% in May from 7.48% the prior month. "As expected, office loan delinquencies have begun to increase and will continue to rise well into next year," said Fitch Managing Director Mary MacNeill. She added landlords are facing tenant downsizing, and in many cases, must offer significant concessions and reduce rent to maintain their existing tenant base. The hotel sector continued to have the highest delinquency rate at 18.63%, an increase from 18.42% a month earlier. Office properties continued to have the lowest delinquency rate at 4.59%, though that was an increase from 3.97% during April. The three other property types Fitch monitors--multifamily, retail and industrial--all saw their delinquency rates rise in May.
And with that in mind; there is this:
JPMorgan Chase looking to sell $716.3 million of bonds linked to loans on commercial properties, Bloomberg reports. The issue will be supported by 36 fixed-rate commercial mortgage loans backed by 96 properties. The securities will be backed by payments on the mortgages and not be an obligation of JPMorgan. The bank’s loan consists of 76.4% of the deal, while 21.6% of debt will come from Ladder Capital Finance, adds Reuters.
One of the traders working on the SP desk said "They need to get these loans off their balance sheet NOW!"; meaning that balance sheet tightening and further tightening of consumer credit will continue unabated; meaning further rise in REAL unemployment figures, declining properties values and all sorts of default in commercial real estate arena [I suspect bonds will be affected heavily [today's widening of the CDS spread in some Euro retailers suggests that may have already started] will ultimately affect munis power to service debt and affect the CE facilities [mostly private insurers]].
Wile JPM offering might seem alluring to some potential investors, the yield which JPM attached to the basket migh suggest otherwise. Some of you might remember that RBS conducted this years first CMBS deal by offering some of the debt in their portfolio with a yield of 90 bips. But many things have changed since April and JPM needed to up the yield on their offering by 21.7% in comparison to the yield on RBS 309.7 million worth of CMBS securities.
One might wonder, why would JPM offer such a high yield [on what is to be an AAA rated offering by Fitch], and there are several answers to that question; this being one of them:
Note the rapid deterioration in the price of REs starting sometime in mid April. While to the casual observer this might seem as a good enough reason why the increase in offered yield by JPM; there is another, more hidden and potentially more damaging reason.
Investors have their doubts regarding the value of the underlying loans; and judging by past experiences are unwilling to invest into CMBS securities unless the return on those securities is high enough to justify the highly risky exposure by engaging in such an investment.
But that is not all. The truth is; JPM offered such yield because it is selling a "black box". This offering can not be considered as anything else than a "black box" simply because; it is my belief; JPM does not have a pricing methodology available to assess the lemon cost of this deal. And by not properly assessing the lemon cost of this offering JPM is putting potential investors at a risk of a high loss, and in order to market this amount of securities it needed to increase the yield. It had no other choice.
This offloading of potentially toxic assets [let us not forget; the price of these assets is done using mark-to-model accounting practice] means only one thing; cleaning and tightening of the balance sheet. The reasons for doing so are listed above, so it is futile to repeat them once again.
If someone is in the mood of trading off of this; suggested trade would be shorting everything related to retailers and hotels [just don't do it if you trade on margin; do not gamble] and buying some CDS on CMBX [while the spread is still relatively cheap]. Probably going short some HY debt issued by those same retailers.
This also, probably, mean that the dollar will continue appreciating against other major currencies but will lag behind the rise in gold.
Godspeed and good luck gentlemen.
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hit is hit, is hit.
If they are losing value and/or liquidity, they are getting hit. Investors purchase the AAA moniker (foolishly enough) to protect principal, and not to identify with the method in which said principal has been lost. Not trying to be a smart ass (okay, maybe I am) but thems is the facts :-)
All true; but I do have one question for you [solely for information purposes].
What will happen, even with the AAA tranches if we see 08 once again. If the liuidity is not there [and I promise you it will not be there; not even for the AAA stuff] what is the stop loss strategy of the holders; just swallow the pill and engage in holding until either liquidity re-appears or market bounces off [ chronologically; liquidity > rise in prices a-la 09-10-4].
I mean what is the best strategy to use if you are not hedged and the liquidity is not there; probably you just swallow the pill and go long.
Again, need to clarify between legacy and CMBS 2.0 but I get what you are after.
The whole problem with CMBS 2.0, for originators and bond buyers, is there is not an effective hedge. This is why there is still hesitancy in the market. As I said, CMBX and TRX are awful proxies because they reference pools with very different collateral makeups that were underwritten like s***.
It is a chicken and egg problem; if there is not enough new issue then there is no new collateral to reference for a new CMBX and TRX vintage. But without effective CMBX and TRX to hedge the new issue, originators and bond buyers are scared to dive in. RBS took a risk and it paid off, JPM is taking one and its looking like they might get burned.
No, no. I get what you are saying; I read about what was to read about this. I know all about the changes in the collateral makeup and the tightening of the evaluation methods in them. Im asking; will there be liquidity available when the time comes. Probably not; since as you say CMBS 2.0 suffer from a terrible lack of people who actually know what the fuck those are and how they are different then legacy CMBS. Also they are probably more cautious now and overcollateralize and use every other possible credit enhancement technique they can use to minimize the risk; but going past the mathematical models and default probability distribution models and judging solely on the events of 08; my question still stands and I ask, once again; will there be liquidity. The answer is obviously no. If they didn't know what they were buying when they bought CMBS [original ones structured in a very fucked up way as you say] I do not think they will know what they are bying know;and the market will react with the lack of necessary liquidity when the time comes also because of that. I know hedges are, at best, arbitrarily set and most probably there is some serious price skew; but I think there are sellers there who are willing to seel a CDS on 5y-AAA tranche of CMBS 2.0 for 50 bips over CMBX benchmark. Its just a pain in the ass when it comes to find one.
I agree. I think liquidity will dry up and pension funds will not make a distinction between legacy and 2.0. A credit committee telling you to sell all FI won't make these distinctions.
Regarding hedging, I think it is awfully difficult to find a seller of single name TRS or CDS 2.0. I had the exact same thought you did but I talked to a few swaps traders and ironically its the same problem you mentioned above the assets themselves; liquidity. No one wants to be in these positions for the long haul and they get scared about liquidity crises. We are saying the same thing.
New Issues??? Are they refinancing a current obligation that JPM is on the hook for? It's not as if nobody else has done it. See Here’s a Big Company Bailout by the Taxpayer That Even the Taxpayer’s Missed! and the games that Merrill has played in the past.
I think yes. Since it clearly states that the only goal of this offering is to move those bonds away from JPM balance sheet and make them a non-JPM obligation. Somewhere in the article is the name of the bank which will service the offering. Also; JPM could have not picked a more disturbing time to do this;y-t-d biggest offering.
These are the words of RBS SBS chief; as reported by Reuters.
http://in.reuters.com/article/idUSTRE6572OE20100608
Im telling you; this offering will backfire on JPM the same way ABACUS did on GS. It just smells bad; really really bad.
Oh; and Reggie; thanks for you contributions and your articles man; a truly fantastic information.
Cheeky, Lancaster is referring to the legacy CMBS trade that has occurred over the past year. 1+ year ago CMBS AAA spreads were at ridiculous levels, you could literally buy an A-1 tranche for a 12-14% yield. Keep in mind that is approximately the 0-30% LTV slice of the loan. Smart funds bought up these senior tranches and have made a killing over the past 12-18 months with the CMBS market recovering. That trade is disappearing as prices are getting closer to their respective relative values and new market volatility could further hamper the technical pressures in the market.
The JPM CMBS is nothing like the ABACUS. Getting access to understanding the underlying collateral is something you CAN do with these deals. Is it always this month's data, is it the lease agreements for the office buildings? No maybe not but this is not a synthetic CDO that has 3 layers of collateral before you even know what type of cash flow these securities are being funded by (or actually referencing in a synthetic CDOs case).
The reps and warranties for the CMBS 2.0 deals are that much tighter after the GGP debacle.
Will this backfire on JPM? To some degree I think yes but not in the way you are describing.
Reggie, it would be very interesting to learn who the holder of the old debt was. JPM may very well be transforming unsecured loans with REITs by refinancing them with secured ones and selling them off in CMBS. Rather smart if you ask me.
Smart as long as the proper disclosures are in the prospectus. You never know when the next SEC fraud allegation may pop up. Of course, anybody with a quarter synapse to fire through should realize that if JPM doesn't want it, why in the world should they buy it? Then again common sense has grown quite uncommon.
Yes indeed Reggie. The idea that sense is common has left the building.
Welcome
Good points. I thought that we might move in the direction of covered bonds, but I think the banks cannot take the on the liabilities on their already negative (real) balance sheets.
As to the B piece buyers, the current ones are facing massive losses and are fighting with the AAA tranches that are leaning toward just liquidating the loans. The B piece buyers are unfortunately the drivers of the work-outs and therefore pretend and extend continues until either the AAA's force foreclosure or the B piece holders blow-up. I would rather see a liquidation in the market rather than have overpriced assets that are not being utilized for other purposes that are profitable at a lower basis.
Spot on, covered bonds are what the market wants but the banks can't handle it.
The b-piece investor world is not going to be the same as it was before. Used to be the specials were always the initial buyer and sold some, but held most in CDOs. With LNR, Anthracite, and JER failing and Centerline and CW being bought out I wonder if their new parents will let the children buy the candy again. My guess is some new players will step into the arena. Despite what ZH always says, my personal tell on the markets (in)sanity will be whether the b-pieces get put into CDOs, again. I will then know that history is completely ignored after high school.
Cheeky good start, there are some other points to add to this post.
The JPM pool differs significantly from the RBS pool in that it has a non-investment grade B-piece. THIS is just as important a reason as the deterioration in the credit markets for JPM having difficulty selling the bonds and having to increase the yield offered.
The RBS pool also had much larger loans, I believe they averaged closer to $40M v. the JPM $19.9M. In the conduit world there is a big difference between sub $20M and $40M+. The RBS pool did not have a B-piece because their loans were much lower leverage (55-60% LTV) qualifying all tranches for investment grade. They did the higher leverage (60-70% LTV) outside the CMBS pool as b-notes/mezz they sold to other investors. This was particularly useful because it adds a degree of validity to the CMBS A-note, and as a result the entire pool, if a fund is willing to take the mezz position in the loan. JPM took a big risk trying to originate the pool with the "B-note" securitized as part of the pool and they got burned when the offering occurred at the same time as the credit markets dipping.
Cheeky, you should cool it with the sensationalist rhetoric. This offering is not a black box, CMBS unlike most ABS, has fairly clear and thorough reporting and data at the time of offering and ongoing during the life of the loans. Most of the loans were made on properties where the rents were either marked-to-market or have already been renegotiated with the tenants. Trust me, the CMBS originators are not lending on properties that have ridiculously high rents in place from leases signed in 05-07 and if they are, they cut the proceeds way back.
Do I think that JPM's pool is too high leverage? Yes. Should they have done what RBS did? Yes. But don't go overboard vilifying this pool as toxic waste just yet.
BoyChristmas, I beg to differ. This stuff is definitely junk and is being distributed before it blows up. Aside from the usual statistics, such as U6, factory utilization, Baltic Dry Index etc, anecdotally, I can attest to the number of vacant and half empty malls littering South California and Florida.
Recently I visited the Sawgrass Mills Outlet Mall near Ft. Lauderdale, for example, and found it nearly empty at 11am on a Tuesday. This mall is a major draw in south florida because of the amazing bargains you can find (ie Ferragamo Shoes under $350, New Religion irregular Jeans for $49, Zegna shirts for 70% off etc) I´ve shopped there for years and June is typically a decent month for traffic, yet for the first time that I can remember, I had absolutely no problem finding parking within the inner parking lots. Plus the retailers are giving away additional discounts on very heavily discounted products. A few admitted that sales sucked and layoffs were imminent.
Clearly retail and commercial properties are in trouble, and I fully expect another leg down in the price of properties, based in part on the opinion of a septuagenarian real estate centi-millionaire that I know quite well.
My 2 worthless federal reserve debt cents <g>
The average size of a loan which participates in this offering is not important here. There are several reasons for that; but mostly because of the high percentage of retail debt in it, and the fact that said retail debt has second highest delinquency rate among all CMBS. Also, I did not call it toxic because of the nature of the loans; I called it toxic because in the current mark-to-model accounting there is no way to assess the participatory percentage of lemon costs in this pool of mortgages.
That is the biggest problem here. If they priced the offering by pricing the participatory loans using mark-to-model all the attributes of said model are not known and therefore a built-in-loss in form of high lemon cost might offset the beneficiary increase in yield. Therefore I called it a black box because:
- the inefficient nature of mark-to-model when it comes to assessing fair value price of participating component and therefore the structure as a whole
- Based on Arora, Barak, Brunnermeir and Ge paper from 2009, regarding the efficient pricing of lemon cost in derivatives [which is also applicable here since we are basically dealing with a CMBS based CBO/CLO/CDO hybrid] information asymmetric [which is present even when dealing with market price discovery] deepens the problem of pricing a lemon cost and thus validates my thesis that this offering really is a black box
- the distribution of top 10 loans [55%] in the total weight of the offering, and the nature of those loans [again; all of them retail debt] is the main problem for me here.
That said; I still stand convicted that JPM did not need to go above RBS yield [no matter the difference in the structure and in the average size of participatory component; assigned rating would offset any "rottenness"] if the pricing was done using efficient methodology and ascribing a lemon costs [+/- 100 bps to weighting percentage fluctuation] to the structure. Basically; if there is no problem with the structure itself, then why up the costs; why not just repackage and sell it as a hybrid CDS/CMBS CDO2 , even if it was a CDO [n!]. Maybe they didn't think of that; I do not know. It just makes it illogical to do the biggest CMBS offering Y-T-.D when the CMBX.AAA is falling and other tranche indexes are not fairing to well either. It just doesn't make sense; and there is the comment from the guy [also mentioned in the article] selling this structure about the urgency of cleaning the balance sheet of such loans. I'm telling you; this will backfire; and will backfire badly. My main metric is the availability of consumer credit, manufacturing data and U-6 unemployment. There is no way loan will be serviceable given what the numbers show. No, way.You say "mark to model" as if they're underwriting some future non-certain cash flows (i.e., they're underwriting lease-up of the property in order to achieve self-sustaining debt service coverage). It's my understanding that all the CMBS shops are underwriting actual in-place rents, marked to market (from a rental income perspective). Is there evidence that's not the case?
New issues; yes. But this is not a new issue. Its refinancing of the JPMs obligations. This is not new debt; this is tightening of the balance sheet with some debt which is priced using mark-to-model not using the model you mention here.
Look:
Meaning; those are balance sheet obligations and JPM is selling them. It is not new debt; it is simply selling the shit they has practically no value. And also; pricing with in-place rents means nothing, just ads another variable [time] but the lemon cost is still unpredictable [ but to a lesser extent].
Cheeky, please trust me on this one. I know for a fact these are not old JPM loans they are selling off. In fact the vast majority of the existing debt encumbering the properties was not even old JPM CMBS from 05. These are new loans on properties that had existing mortgages on them.
As for the mark to market rents and underwriting, I think the distinction that was being made is that old CMBS loans were often underwritten with proforma projected rents while these loans are underwritten with in-place rents, or marked down rents if in-place rents are over market (determining market rents is a whole new thread). I do agree with Reggie that ultimately macro viewpoints have to come into place, because you may view that new market rents (leases signed in the past 12 months) may still see further deterioration.
As for the lemon cost and asymmetric information, I completely agree that ABS suffers from under estimating this. I do think CMBS mitigates the lemon cost more than other ABS, but you are right that if I had choose, I would rather be JPM originating the loans and selling the bonds than the pension funds buying them. CMBS lenders are ultra short-term arbitrage investors and nothing more.
See comment below.
The newest one.
I don't believe this is true. They originated these loans over the last 6 months specifically for sale. These are not legacy loans from 2007-2008 that could not be previously sold.
All CMBS loans are originated and held "on the balance sheet" before being securitized.
when will investors finally decide that buying the packaged crap from Wall Street is a LOSING proposition?
Who in their right mind is still buying this stuff? And why?
Certainly JPM is setting up their "plausible deniability" within this offering already.
When will someone have the balls to ask some straightforward, honest questions of these Wall Street Packagers of trash?
"when will investors finally decide that buying the packaged crap from Wall Street is a LOSING proposition?"
At the same moment they figure out you can never win at black jack, craps and roulette... central limit theorem, dumb asses...
Then you have to ask yourself...
The buyers of these fresh JPM junk bond turds... are they pension and mutual fund geniuses losing some one else's money?
No offense Leo...
"Who in their right mind is still buying this stuff? And why?"
I do not know..., but the funds they are using seem to be wet and slightly sticky.
Pension funds, anyone dumb enough to use edward Jones etc
For example, some beaurocrat in charge of any public fund, who is required to find yield investments that will (mathematically) close the gap by some future date, and is hoping to be long gone when that date arrives. An obvious lie backed up by a name bank is just what is needed in this case.
Pension funds, anyone dumb enough to use edward Jones etc
Pension funds, anyone dumb enough to use edward Jones etc
There's always Maiden Lane XC
Word on the street here in the USA is that banks are really working with commercial. Extending loans, forgiving delinquencies, and tacking the missed principle and or interest payments onto the back end. Some light cramming down also.
Current Wells Fargo policy is that they will not foreclose on CRE
Yeah, until the loans get sold off and the banks dont need to play nice anymore. Why the fuck go trough all the hustle when you can just sell something that is worth, maybe, 100 million for 700 million and play stupid when the offering either defaults or or the constituents deteriorate to a such a degree that no one will take the other side of your trade. And you can deny any wrongdoing by saying there is no efficient way to price lemon costs [which in mark-to-model pricing is very true; you negate the market; you skew price discovery].
I was in the wrong line of business; I should have been a banker.
Exactly right Cheeky, same old game and no accountability. You would wonder at the audacity of the rating agencies in the face of the Moody's investigation, but no criminal charges for individuals means no fear. I mean whats the worse that can happen, they get fined and possibly go out of business then on to a new job possibly at JPM.
What I find unbelievable is that there are enough greater fools availble. Should they not be in short supply?
I can't remember who first said this, but it teaches an important lesson:
"The supply of fools in the world, while very great indeed, is not infinite."
"There is a sucker born every minute" P.T. Barnum
Don't ever buy anything pushed by Goldman and now JPM.
Great piece, great report - but it leaves me feeling puzzled. They must have known this would get red flagged, and pick up a lot of (press) attention, illuminating what looks like a very desperate action.
If they are pushing this boat of garbage out in broad daylight, then they must be in very deep trouble. This looks like an act of desperation, possibly even the kind of miscalculation that could lead to a great unravelling?
+100
Great fun to sit back and enjoy the show!
So naturally everyone should step up and help JPM wipe it's ass.
Don't F' with the Irishman.
http://i46.tinypic.com/124ao8m.jpg
IRISHMAN?
I thought Jamie Dimon was Puerto Rican?
Now there's an asshat for you...
You only need to read this and see the fucking insanity of the rating agencies.
I mean; WHAT THE FUCK FITCH:
Nuff fucking said; they are insane.
LTV of 78.2% what a bargain. The illusion of a sufficient equity cushion. This deal was discussed by a panel at the 11th Annual US Real Estate Opportunity & Private Fund Investing Forum last week in relation to the question of whether or not CMBSs would ever come back. I recall clearly the party line was that these would be offered at no higher than 65% LTV, which was considered conservative. Nearly 80%, in this environemnt, is not conservative.
None of these deals are safe unless the investor conducts its own due diligence review and underwriting of the loans that comprise the offering. The bankers are not to be trusted. Simple as that.