Wall Street Sows the Seeds of Overdue Commercial Real Estate Collapse
JP Morgan Chase has awarded Redico Corp., a Southfield Michigan commercial real estate developer, a $27 million in loan refinancing backed by a pool of more than $1 billion in commercial mortage-backed securities that it is selling off to “lucky” (read: uh, psychologically handicapped) investors in a deal set to close this week. Anyone up for a commercial real estate collapse? This is just one symptom of a derivatives market not tamed by the senses in the aftermath of the banking crisis, but instead growing. Moody’s last week criticized already the credit ratings of the $1.1 billion bond issue. According to Moody’s, the pool “is shortsighted in an environment of historically low interest rates, and underestimates the refinance risk of loans that mature in ten years.” But, the truth of the matter is not that the credit standards are loosening due to shortsightedness, but instead due to Wall Street’s purposeful agenda of sowing the seeds of the next crisis: the commercial Real Estate market.
The building is located at One Kennedy Square.
These sorts of deals are par for the course in today’s increasing lax environment dominated by finance capital via state mechanisms. With unemployment in Detroit well above the official 19.6% number for August, though, this deal is particularly interesting. The debt deal in Detroit marks the first time since 2007 that a Detroit office building received a securitized loan.
“The markets have been closed to Detroit,” says Dennis Bernard, president of Bernard Financial Group, a commercial-banking firm that represented J.P. Morgan and the building’s owners in the arrangement of the debt deal. “This time, we thought we could do it. We were like the little engine that could.”
With Wall Street looking to increase the issuance of commercial-mortgage securities, due to yield-chasing investors gobbling bonds us, the volume of new issues is expected to $38 billion in 2012, up more than $5 billion from last year.
The Morgue did not comment on Moody’s report, and neither did Moody’s.
There are reasons to be concerned over Detroit debt. With the building 96% occupied, some believe this number could fall drastically, especially due to the end of the car in the USA. 27% of Motor City’s downtown office space is vacant, one of the highest rates in the nation. Indeed, in not quite five years, leases on about half of the spaces located in the building are set to expire. In 2017, tax incentives will expire, increasing the building’s operating expenses.
Plenty of reasons to worry about the commercial mortgage revival in the wake of the banking crisis: the bonds issued by Wall Street have been scoffed at by some investors due to their lack of diversity, as well as an increase in the loan-to-value ratios. In early 2011, WSJ Reported:
The average “stressed” loan-to-value ratio on bonds valued at about $8 billion offered in 2011 is 89%, up from 82% on the nearly $10 billion of bonds sold in all of 2010, according to data from Amherst Securities in New York, a dealer and market maker in mortgage-backed securities.
When ratings firms evaluate a bond, they consider what would happen to the value of the property if the economy is weaker and unemployment increases such that the value of the property declines further. This is called the “stressed” loan-to-value ratio.
In 2006, before the recession, the average stressed loan-to-value ratio stood at 99%, rising steadily to about 110% in 2008.
What is particularly worrying about the rising loan-to-value ratio this year is that the quality of assets underpinning new bonds has deteriorated, market participants said. Also, the speed with which the ratio has increased is worrisome, some said.
But others said that last year was a period with conservative underwriting, so some slippage is reasonable.
“The rating agencies applied ultraconservative metrics by which to measure credit quality,” said Lisa Pendergast, managing director of commercial mortgage-backed securities strategy and risk at Jefferies & Co.
Ms. Pendergast said the composition of commercial mortgage-backed securities is “a reflection of the loans out there,” and if investors are worried about the reliance on retail or the quality of underwriting they “should vote with their feet and walk away.”
Some market participants said that the first few securities sold this year had properties with many strong anchor tenants. The more recent ones have been backed by some buildings occupied by weaker businesses. For example, one of the more recent securities included a loan collateralized by a building with a Borders Group Inc. store as a tenant, the book retailer that filed for bankruptcy protection this year.
The decline in asset quality this year is clear “around the edges,” said Paul Norris, executive vice president and head of structured products at Dwight Asset Management Co. LLC in Burlington, Vt. “But if we are still stumbling along in the economy, with a little blip, property values will go down quite a bit, so there is less wiggle room.”
Investors also are bothered by the fact that 60% of the loans contained in some securities are for retail property.
“That’s a concentration people may be concerned about because there has been no turnaround in this sector,” said Darrell Wheeler, senior managing director of strategy at Amherst Securities. “These are supposed to be diverse pools, so the investor base doesn’t like to see more than 30%” of any one type of property.