AAA CMBS Market’s Improvement & General Growth Implications

Much of this is due to the recent decision from the FED to make CMBS eligable to TALF backing. Whatever the reason, the CMBS market has made a stunning reversal from the end of 2008

From Markit:

Markit, a financial service firm, is described as a leading provider of industry data and pricing products and services that are used globally by more than 250 asset management firms to help them monitor risk, mark-to-market, develop accurate forecasting models and asset class benchmarks.

Markit released the following chart of their AAA(Triple A) Commercial Mortgage Backed Securities Index that had been previously issued at 100(par). These securities are representative of those on which market professionals have expressed great concern regarding the lack of available refinancing options in the current credit environment. This concern was recently underlined by the declaration of bankruptcy of General Growth Properties (GGWPQ) which was viewed by many as having adequate cash flow with which to fund the interest payments on current debt, but could not find a lender to refinance the debt that it needed to roll over. Farralon recently provided Debtor in Possession (DIP) financing.

It may be the fact that Farralon and Pershing Square competed to offer financing with the net effect that General Growth Properties was acknowledged to have received a better agreement that had been previously expected that has begun to shift expectations regarding CMBSs. It is too early to offer an explanation for the dramatic improvements in market sentiment as seen in the chart below for these securities. But, certainly a positive shift has occurred since early March 2009.

This is one piece of information in a sea of swirling bits and pieces and one observation does not make a trend. Even the multiple observations that have been evident since December 2008 which appear to reflect a strong trend of economic recovery do not permit one to forecast with certainty that the trend will continue. Such, has been the impact of unforeseen events of the magnitude of 9/11. What can be said is that there is historical precedent that this trend which appears quite similar to previous recoveries has a high likelihood of continuing.

The typical pattern is:

First, there is a psychological recovery as reflected in stock and bond markets as investors are willing to buy into risk in anticipation of recovery. During this period many continue to bemoan the lack of fundamentals to support investment activity and the media continues to provide time to those whose forecasts continue to be bearish. If markets continue to improve, the costs of financing are reduced by lower bond yields and higher stock prices and businesses and market participants eventually resume activities that eventually result in profits.

For business recoveries no one rings a bell, it is a process. The pattern is psychology first, fundamentals second. This chart reflects improved psychology. If so, then the refinancing risk for existing commercial debt is diminishing.

The trend begun December 2008 continues.

The importance of this on the GGPWQ Chapter 11 cannot be understated. Anything that causes the CMBS market the strengthen does two things. It enables lenders to more easily sell refinanced debt & in essence encourages them the do just that rather than having them position themselves to replace said debt with equity. It also places a floor on CRE prices and by default, properties that General Growth may decide to sell. The more money received from any asset sales increases the odds of equity survivability.

The Fed said in announcing the facility “”The inclusion of CMBS as eligible collateral for TALF loans will help prevent defaults on economically viable commercial properties, increase the capacity of current holders of maturing mortgages to make additional loans, and facilitate the sale of distressed properties,”. Emphasis mine..

It is not a big leap to then say that those properties of General Growth that were commercially viable at the time of the filing (the vast majority) would then stand a chance of TALF backed refinancing in Chapter 11. If this is then true, the outlook for the equity then increases. Now, a lot can happen between now ans next year when this stuff start getting taken care of. Properties that are performing today may just as well see performance deteriorate as they may see it improve and their lies the $27B question.

Remember, it was not the operating performance of General Growth that drove int into Chapter 11, but the lending markets. In December of 2008, then Treasury Secretary Paulson was told in a letter from a dozen commercial real estate trade groups “Right now, we believe there is insufficient systemic capacity to refinance expiring, performing commercial real-estate loans,”.

My thought has been and still is General Growth’s operations will be performing better and there will be plenty left for shareholders.

Usual disclaimer. This is a highly speculative bet that depends greatly on the whims of the US legal system. You must be prepared to lose 100% (or close to it) in this investment before you invest. BUT, if we are right (I think we are)……..wow will it be good…

Disclosure (“none” means no position):Long GGWPQ