Now that hedge funds have finally started piling into the "Big Short 3.0" trade, which as we first explained back in June is basically shifting the CMBS short from malls to hotels (via the overexposed CMBX Series 9 index whose BBB- tranche is the fulcrum), every incremental development in the sector is closely scrutinized.
And judging by the lack of appreciation in the BBB- tranche of the CMBX Series 9 index which has the highest exposure to hotels - despite a very modest rebound earlier this week on vaccine hopes - developments continue to show accelerating deterioration with little sign of recovery on the horizon.
A recent tailwind blast for the CMBX 9 shorts came from a September report from NorthStar according to which, without aid 74% percent of US hotels said they expect to lay off more employees, with a whopping two thirds of properties warning they won't be able to last another six months at the current projected revenue and occupancy levels. Needless to say, should two-thirds of the US hotel industry fold, shorting the CMBX S9 BBB- could well be the most profitable (institutionally sized) short in recent history when the Fed has effectively made shorting impossible.
Since then it's only gotten worse for the hotel sector, which as even the FT now writes has hit New York hotel industry especially hard with four out of five properties underpinning commercial mortgage bonds now on the verge of default.
Normally among most vibrant of global hotel markets, New York has been hammered the coronavirus pandemic has left business travel and tourism deeply depressed ravaging cash flows. The effects have ricocheted into financial markets and hit the nearly $4bn of hotel mortgages in New York that are bundled into commercial mortgage-backed securities particularly hard.
The virus has also compounded years of overbuilding and created a glut of vacant hotel rooms. And while the prospect of a coronavirus vaccine, following this week’s breakthrough by Pfizer and Germany’s BioNTech, offers a glimmer of hope, it is unlikely to come soon and avert a bleak winter for hotel owners and the investors that lent them money.
How bad is it?
According to Vijay Dandapani, chief executive of the Hotel Association of New York City, if half the city’s 640 hotels survive it will be a "great" outcome. While occupancy rates have recovered from their worst point in April where occupancy was down more than 60% year on year, they remain 20% lower than for the same month in 2019, a level which means much of the debt backing the properties will be impaired (i.e., default). Should New York impose a new round of draconian lockdowns, it will only get worse. Dandapani said that a best case scenario in which a vaccine is authorized would have “zero impact” on the hotel industry for the rest of the year, and possibly lead to the return of some tourism-related business in early 2021.
"But it’s fickle,” he said. “Realistically we aren’t going to see any improvement until the second quarter . . . The industry is really bleeding. It’s not just on life support, it’s comatose."
For proof look no further than the latest data out of CRE consultants TREPP, according to which 37.7% of all New York hotels underpinning CMBS deals now sit on a watchlist meant to warn investors a mortgage is about be transferred to debt collectors known as special servicers. A loan may be added to the watchlist for a number of reasons, such as if the borrower’s income has dropped or they have recently missed a payment on their mortgage. In any case, once it hits special servicing, the loan is effectively in default unless the debtor and creditor manage to work out some agreement where the debt will remain "whole" after some pre-agreed restructuring.
What's scarier is that a further 44.7% of loans have already been transferred to special servicers to either find a way to get borrowers paying their mortgage or to foreclose on the properties.
Together, it means more than 80% of the city’s hotels backing CMBS deals, approximately $3.1bn, are impacted adversely from coronavirus, far more than the national average of 71%.
"It’s terrible. There is no demand right now," Manus Clancy, head of research at Trepp told the FT. "We’re going into a period of time when you would normally expect demand to be high. It’s the holiday season. People want to come to New York. They want to see the Thanksgiving parade and see the store fronts and go to Broadway. It’s now going to be a very dark time."
One place that is already dark is the 476-room Hilton Times Square, which hotel closed permanently last month after its owner, Sunstone Hotel Investors, handed back the keys to lenders. The property backs a $76.5MM loan that makes up 17.4% of a 2011 CMBS deal. The mortgage on the loan had already been over 90 days delinquent in August. Sunstone Hotel Investors recently valued the property at $61m, down from $246m in 2010. This means that the Loan to Value is now well above 100% and - all else equal - the creditors are looking at losses of at least 20%.
Another Times Square hotel, called The Hotel, admitted that revenues had become "nothing short of catastrophic" when it asked for 90 days’ forbearance from paying its mortgage, according to the special servicer’s report. S&P downgraded the previously triple B minus, investment grade-rated tranche of the deal — which is also heavily exposed to retail properties — to the junk rating of B plus. It will be in default as soon as the forbearance expires and is not extended.
Ironically, even one of Trump’s own properties was also caught up in the turmoil. While all of Trump’s four properties bundled into commercial mortgage-backed securities are current on their loan payments, Trepp placed one - the $6.5m mortgage on the Trump International Hotel at 1 Central Park West - on its watchlist after the property’s income fell substantially.
"I think New York is going to struggle for a while,” said Jen Ripper, head of CMBS at Penn Mutual Asset Management. “It is highly dependent on tourism and business travel."
As the FT concludes, "coronavirus has upended the investment thesis for large cities such as New York. Tourism has vanished and analysts warn business travel may never return as companies realise they can function without spending money on expensive business trips to big cities."
It's also why, as we said as early as June, shorting hotel-exposed CMBS is now the latest Big Short (version 3.0) in credit, after the Big Short 2.0, which focused on malls, made billions in profits to investors such as Carl Icahn.
Dave Goodson, head of securitized fixed income at Voya Investment Management said "urban core" property has moved from the area that owners sought exposure to being the sector of greatest concern. "It’s been turned on its head," he added.
It's also why until there is a widely accepted covid vaccine and until tourism make a complete return, shorting the fulcrum BBB- tranche of the CMBS 9 index will be the best way to profit from the devastation unleashed by the pandemic, especially since the Fed has so far refused to intervene and purchase any commercial real estate-linked securities. Of course, if and when Powell does step into the CMBX market, all bets are off.