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Canadian ABS/MBS

Research
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Securitization Files November 5, 2001


CMBS Performance: Gimme Shelter
Peter Weldon Joanna Zapior, CFA Tina Lai, CFA Trevor Bateman, CFA, CA Geoff Watson, CFA
416-956-3211 416-594-8498 416-956-6273 416-594-7992 416-594-8146

CMBS A slowing economy has resulted in a jittery corporate debt market and wider spreads. Chasing
yield to compensate for lower interest rates and finding credits likely to be resilient in a
structures have downturn is becoming a challenge. Spreads have recently stabilized but have settled at higher
performed well levels and our view is that the risks persist for further widening in the corporate sector, as
in a difficult economic and corporate fundamentals weaken. Structured fixed income products, including
market since CMBS, are built to withstand weaker asset performance during economic slowdowns, and
as a result should provide protection in a downturn.
September 11th
Examining the performance of Canadian CMBS is difficult, as it is a young market with mostly
buy and hold investors; however, the U.S. market can provide guidance. In this report, six U.S.
CMBS deals are examined, including single asset and well diversified structures. The AAA
tranches are analyzed from a market and asset performance perspective. The results are
encouraging, given the structuring and the current strength in the real estate market. Although
the Canadian CMBS market lacks the depth of the U.S. market, the recent resilience of the U.S.
structures is notable, given that similar levels of credit enhancement, and safety of principal, are
built into Canadian deals. In prior periods of weakening in the U.S. corporate market, we
have seen less spread impact on the highest rated tranches of CMBS structures.

Spreads over Spread


MSDWC
U.S. treasuries GSMS Single Asset/Loan CMBS
have remained 180 LBUSB
Spread (bps)

stable over a 160

period of 140
extreme 120
volatility 100
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MSDWC Spread
GSMS Multi Asset/Loan CMBS
160 JPMCC
Spread (bps)

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CIBC World Markets


Nov.5, 2001
The tables below detail the characteristics of the deals in our sample. Most notable is that the
strong spread performance is consistent across a number of underwriters and property types.
Recent performance trends have been virtually identical across structures, however,
securitizations comprised of diversified and office properties have continued to trade at the
tightest spreads.

Performance is Single Asset/Borrower CMBS (Details)


Property AAA Size Deal Size
strong across a Deal Name Lead Manager Coupon
Type (MM) (MM)
range of Morgan Stanley
MSDWC 2001-280 A2 Office $56.30 $269.80 6.494%
structures Dean Witter
diversified by GSMS 2001-1285 A2 Goldman Sachs Mixed Use $168.00 $372.30 6.526%
LBUBS 2001-WM A2 UBS Retail $425.50 $800.00 6.530%
underwriters
and asset Multi Asset/Loan CMBS (Details)
mixes Property Issue Size Deal Size
Deal Name Lead Manager Type (MM) (MM) Coupon
Morgan Stanley
Diversified $617.40 $1,026.40 6.390%
MSDWC 2001-T3 A4 Dean Witter
Retail 65%
GSMS 2001-GL3A A2 Goldman Sachs $412.70 $624.50 6.449%
Office 35%
JPMCC 2001-CIBC A3 JP Morgan Diversified $607.00 $607.00 6.260%

Yield Despite the high levels of credit protection in each of the six structures examined, and the
accompanying AAA rating, it is notable from the two charts on the previous page that spreads
enhancement are well above 100 basis points in the ten-year term. What is much more noteworthy is the
accompanies recent spread performance. Since September 11th, the corporate debt market has weakened
defensive appreciably relative to government debt, but the CMBS market has suffered much less. CMBS
characteristics spreads have been remarkably stable, and after widening when the U.S. bond market re-
opened on September 13, have tightened to levels approaching those in early September.
The stable spread performance demonstrates the market’s comfort level with both the
underlying real estate assets in the structure and the structures themselves.

The protection structured into securitized offerings makes each type of structure worthy of
further examination given the performance in the current environment. The U.S. CMBS deals
in our sample are useful to illustrate two critical points.
• Firstly, the U.S market has recognized the principal protection built into CMBS
structures, shown by the consistency of the spreads, and has not sold off CMBS
holdings to the extent that it has traded out of corporate debt since September 11th.
• Secondly, the structuring in CMBS deals provides at least the same level of credit
enhancement as ABS offerings, as shown in the tables on the following page.

The structures The most important structural considerations, outlined on the following page, are:
justify recent • Credit Enhancement – Refers primarily to the level of subordination in CMBS structures.
performance The single asset/borrower structures normally have much higher levels of credit
enhancement than more diversified offerings.
• Loan to Value – Typically, the LTV at the time of the transaction will be 50-70%, but that
number is significantly smaller when compared only to the AAA tranche, rather than the
entire mortgage.
• Debt Service Coverage Ratio.
The structuring and asset performance measures are similar across both diversified structures
and single asset deals. The only notable exception is credit enhancement levels, where single
asset/loan deals are normally protected by significantly higher levels of subordination.

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CIBC World Markets
Nov. 5, 2001
Significant Single Asset/Borrower CMBS (Statistics)
Credit
protection is Deal Name Enhancement WALTV WADSCR WAL (years) # Loans
# Delinquent
Loans
built into each (AAA)
MSDWC 2001-280 A2 32.84% 59.60% 1.53 10 1 0
structure in the GSMS 2001-1285 A2 38.84% 59.30% 1.62 10 1 0
sample LBUBS 2001-WM A2 34.10% 64.60% 1.60 9.9 1 0

Multi Asset/Loan CMBS (Statistics)


Credit
# Delinquent
Enhancement WALTV WADSCR WAL (years) # Loans
Deal Name Loans
(AAA)
MSDWC 2001-T3 A4 15.00% 61.60% 1.77 9.7 158 1 ($1.9MM)
GSMS 2001-GL3A A2 19.50% 56.70% 1.81 9.8 5 0
JPMCC 2001-CIBC A3 22.25% 70.30% 1.34 9.6 165 0

Asset Corporate bonds have softened in recent weeks and tightening is unlikely in the near term.
Widening has been most apparent in obvious sectors including airlines, where traffic has
fundamentals dropped dramatically, and insurance, where significant liabilities will cut into profits. U.S. real
outlook is estate, a high profile sector after September 11th, was briefly pressured after the attacks but
positive quickly found support after the initial shock of the tragedy. Lodging and leisure properties
have been negatively affected, mostly on travel and holiday concerns, due to both the economy
and recent events. The outlook for real estate overall, however, is much less dire. Demand for
office space, residential complexes and industrial-use properties has remained strong to date.
CIBC World Markets Equity Research concludes that established office properties,
particularly in large Canadian urban areas should continue to benefit from a gap between
rents embedded in existing leases and current market rates, and contractual income
streams.
Additionally, CIBC World Markets Equity Research reports low vacancy levels in the office
property market. Current vacancy rates in Canada and in major Canadian cities are shown
below and compare favourably with similar U.S. data.

• United States 10.10%


• Canada 6.3%
Toronto 4.3%
Calgary 7.7%
Montreal 8.5%
Vancouver 5.1%
Ottawa 3.4%

CIBC World Markets Equity Research estimates that overall office vacancies will increase 1%-
2% over the next year as a result of a general economic slowdown, with the effects being most
acute in the suburban areas of Ottawa and Toronto, where the technology sector downsizing
will have the largest impact. An economic slowdown, provided the trough of the downturn is
not deep, would not necessarily be overly negative for trophy buildings in metro areas. In
addition to the reasonable level of security provided by a base level of demand for well-
located, high-end properties, a lack of new supply is a significant positive for existing
properties, as developers become wary of creating excess capacity in a recession.

As liquidity The stable spread and asset performance of U.S. CMBS structures demonstrates the
market’s comfort level with both the assets and the structures. Despite relatively illiquid
improves, so to conditions through the end of September in U.S. corporate bonds, the CMBS market had
should the sufficient liquidity and depth to provide good selling opportunities at reasonably tight spreads.
“safe haven” Although there is limited liquidity in the Canadian CMBS market, the level of safety built into
status of the structures is on par with similar offerings in the U.S. The resilience of the U.S. CMBS
market and the lack of selling in recent weeks suggests that as the market matures, the Canadian
Canadian CMBS market will become a relatively safe haven from spread widening, while providing both
CMBS yield and safety of principal.

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CIBC World Markets
Nov. 5, 2001
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Nov. 5, 2001

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