Given that hospitality is generally considered riskier than other commercial assets, hotel loans get much scrutiny. Recently, b-buyers have increased their scrutiny of franchise expiration dates for franchised limited- and full-service hotels. Data have supported that the probability of default is high and cash recovery amounts are low from foreclosed hotels that have lost their franchises. Therefore, b-buyers have concerns for franchised hotels that have less than five years remaining in their franchise agreements and those agreements that have cancellation rights within a five-year window. They are actively kicking those loans out.

Previously, as long as the loan was structured with a Property Improvement Plan (PIP) reserve, either at closing or over time such that the reserve accumulated to $7,500/room (roughly $500,000 on a typical 65- to 70-room limited-service hotel) prior to the franchise expiration, b-buyers were satisfied. However, many older franchised properties are not being renewed at all, making the reserves somewhat useless as alternative franchises are often not available in the market.

“Now we either have to get early renewals or show that the property is consistent with current brand standards in order to get deals done with franchise expirations less than five years away,” commented Jay Bhakta, a senior loan originator at the ValueXpress Jackson, Mississippi office.

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In its view, the drop in credit metrics from 2010 to 2011 is much starker than the change in top-level metrics that has taken place over the first three quarters of 2012. While it certainly has noted some negative trends, such as the increase in more highly levered interest only loans, CS does not, at least at this point, find these trends overly troubling.

That said, CS generally looked at overall trends in this analysis rather than individual deals. While the overall averages may have exhibited only small shifts, surely some deals are better underwritten than others.

Deals still need to be evaluated on a case-by-case basis, especially as investors gravitate further down the credit stack. CS has, for example, seen loans in some deals that have again been made using pro forma assumptions. While these may be justified on an individual basis, as they have learned in the past, it can be a slippery slope; a quirk in a single loan can quickly manifest itself to become a common trend across all deals.

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The UBS-Citigroup offering is backed by 32 mortgages on 38 properties, with office properties representing 26.4% of the collateral pool, followed by retail at 22.5%. Hospitality properties were 15.4% of the collateral pool.

Three of the four super-senior classes priced in line with guidance. A $154.4-million tranche of 4.7-year bonds and $235.9 million of 9.7-year bonds both priced at 130 basis points (bp) over swaps. Meanwhile, $37 million of 2.6-year bonds sold at 80 bp. The other super-senior tranche — Class A-AB, with $44.4 million of 7.2-year bonds — exceeded guidance by 10-15 bp, pricing at 120 bp.

Among the subordinate bonds, the junior triple-A rated bonds, double-A rated bonds and single-A rated bonds also priced in line with guidance. But lackluster demand forced UBS and Citigroup to sell bonds rated Baa1/BBB (high) by Moody’s and DBRS at 725 bp, up about 50 bp from price guidance. And the paper rated Baa3/BBB (low) went for 950 bp, up about 150 bp from price guidance.

“The results of this offering are great news for CMBS borrowers and originators,” commented Michael D. Sneden, Executive Vice President of ValueXpress. “We are seeing an immediate decline in spreads to borrowers to the swaps-plus-350 area for a 10-year term, resulting in interest rates of about 5.6%, down from 6.00%-6.25% as recently as 30 days ago.”

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“Ratings are a condition precedent to closing and settlement,” Goldman Sachs and Citigroup said in their joint statement. “Standard & Poor’s had previously informed Goldman and Citi that it was prepared to rate the transaction.”

“S&P is reviewing the application of our conduit/fusion CMBS criteria in relation to the calculation of debt-service coverage ratios,” the risk assessor said in a statement. ”The review was prompted by the discovery of potentially conflicting methods of calculation.”

The action appears to be related to the relatively low subordination levels of 14.5% awarded to the triple-A senior classes of the Goldman/Citi transaction. This compares with subordination levels of 17%-21% for other multi-borrower transactions since the revival of CMBS issuance in April 2010. Investors noted no significant difference in the credit quality of the collateral loans that would warrant the lower subordination levels awarded by S&P on the Goldman/Citi transaction.

Goldman and Citi attempted to salvage the deal by creating a super-senior portion of bonds with 20% subordination and a junior triple-A class with the original 14.5% subordination. This restructuring became moot when S&P pulled the rating altogether.

Now Goldman and Citi are trying to regroup on their deal. One possibility is to have the deal rated by Moody’s. Another is to include the collateral in another offering being teed up by other conduit shops. Despite the outcome, the situation is another setback for the CMBS market recovery.

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The bonds were 2-3 times oversubscribed at the initial pricing guidance and even after dealers pulled in spreads, Class A1 was 2.25x oversubscribed and Class A2 was 1.75x oversubscribed. Elliott Management acquired the B-piece after strong competition.

“This is another great milestone in the recovery of the CMBS conduit loan business,” noted Michael D. Sneden, Executive Vice President at ValueXpress. “It is clear there is tremendous demand for CMBS. It is now up to us, the origination machine, to find and close loans to feed the issuers,” commented Sneden.

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The issue contains 36 loans with a weighted average debt-service coverage of 1.64x and a weighted average loan-to-value ratio of 61.5%. The loans in the pool have a weighted average interest rate of 6.40%. Although there was indication of some slow selling, particularly Class B (rated AA/Aa2), all the classes eventually sold, according to dealers.

“According to our calculations, the weighted average coupon paid to bondholders was about 5%,” noted Michael D. Sneden, Executive Vice President at ValueXpress. “This represents a healthy spread of 140 basis points between the rate paid the bondholders and the 6.40% paid by borrowers. This excess interest spread represents ongoing profit to the issuer that can be monetized into up-front profit through the sale of Class X bonds, an interest-only class that pays the excess interest between the borrowers and the bondholders to the Class X bonds,” said Sneden “I am no expert in figuring out the proceeds from the sale of the Class X bonds, but they appear to be well in excess of the 1%-3% of the total issue amount that was typical prior to the 2008 CMBS market collapse.”

“Frankly, I hope the issuers made a lot of money. This will create economic incentive for other issuers to consider originating loans for future CMBS issues,” commented Sneden.

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“A big part of seeing new CMBS issues is going to be more properties trading hands and those that are maturing getting refinanced,” Pat Sargent, president of the CRE Finance Council, told GlobeSt.com. “We’re starting to see that, but because of the valuation drops, you’re going to have to have new equity in a number of cases.”

Sargent said it’s encouraging that a conduit sale of this magnitude, as opposed to the three single-borrower CMBS deals that occurred late last year, is going forward. It’s more than twice the size of the $309.7-million issue from the Royal Bank of Scotland in April — the first such multi-borrower deal in nearly two years. “We see this as a positive return to capital market execution,” he said.

Known as JPMCC 2010-C1, the deal is backed by 36 fixed-rate commercial mortgage loans secured by 96 properties in a variety of asset classes across 31 states. Largest of the loans is on Gateway Center, a 623,972-square-foot lifestyle center in Salt Lake City, UT with $101.1 million in debt. Loans held by JPMorgan Chase Bank comprise 78.4% of the pool with the remainder originated by Ladder Capital Finance.

According to a presale report from Moody’s Investors Service, the pool has a weighted average loan-to-value ratio (LTV) of 80.4% and a debt-service coverage ratio of 1.56X. Similarly, Fitch Ratings said in its presale report that the 78.2% LTV and 1.37X DSCR it assigns to the pool compares favorably with the average 110.7% LVT and 1.05X ratio across Fitch-rated conduit transactions from 2007 and 2008.

“That reflects a return by loan originators to prudent underwriting,” said Sargent. Both Moody’s and Fitch have assigned their top ratings of AAA to $608.9 million of the loans. Among other strengths, the loans in the pool are geographically diverse and tend to be backed by properties with strong tenancies.

However, the agencies do note risks along with the positives. Moody’s said about 71% of the pool balance is exposed to a single property type: anchored retail, although anchored retail is seen by the agency as a “less risky” asset class. “Property type concentrations increase asset correlations, which affect pool default and loss distributions,” Moody’s said in its presale report.

Fitch also sees the heavy retail concentration as a liability, but for a different reason: The agency maintains a “negative” outlook for the sector. A JPMorgan spokesman said the company has no comment on the agencies’ reports.

The conduit sale, which reportedly is expected to price in mid-June, comes as CMBS has been outperforming other forms of debt when it comes to yields. Citing Barclays data, Bloomberg reported that top-rated CMBS yielded about 309 basis points more than Treasuries as of June 4.

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