READING THE TEXAS TEA LEAVES: WILL LENDERS ABANDON CMBS REFINANCINGS TIED TO THE ENERGY SECTOR? February 2015

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1 By Andrea Bryan, Managing Director A s oil prices skid to levels not seen since 2009, the prospects for refinancing commercial mortgage-backed securities (CMBS) loans to assets in the oil patch take on new meaning. Of the nearly $300 billion in CMBS loans that come due between 2015 to 2018, nearly $7 billion are secured by commercial real estate properties located in Texas, Oklahoma, North Dakota, and Louisiana, according to a review of data from Trepp LLC. The loans were originated between 2005 and 2008, and the vintage was originated at the height of the most aggressive lending boom of the last decade. Many of these assets were susceptible to default due to the aggressive leverage and more conservative current lending standards, but the impact of lower economic performance due to declining oil prices will put additional stress on their refinancing prospects. Market participants point to abundant capital available to refinance legacy CMBS loans, but the willingness to lend to the energy sector amid a slump in energy prices will depend on market perception of the depth and breadth of any downturn. Short-Term Jitters The market is already on edge, exemplified by two major Houston office buildings recently pulled from the market due to market conditions or buyer withdrawal. On the other hand, the newly constructed JW Marriott hotel in Houston was able to secure financing of $115 million for the 328 room property, according to a report in Commercial Real Estate Direct. Moreover, a recent report by the Dallas Fed noted that there is a slight pull-back in hiring and some drop-off in leasing activity in the commercial real estate sector in Texas. Among the major assets up for refinancing are The Houston Galleria s $800 million of debt. The loan matures in November The Galleria is a well-known destination center and while it is likely to face competition from a newly constructed retail center, it has performed well. With a 70% LTV and a debt yield in the 7% range, it should have no problem securing refinancing. The same goes for Houston s One City Center s $70 million loan, which matures in August 2015, and Fort Worth s Burnett Plaza s $114 million matures in April 2015, as their tenants are diversified with leases that extend beyond the next few years. We expect these types of core, well-positioned assets located in Houston, as well as the Dallas CBDs and submarkets, to remain competitive. While still energy-dependent, both cities economies are more diversified than they were in the 1980s. More importantly, they are likely to benefit from the global hunt for yield as investors reach into secondary markets for compelling values. Strong property assets are producing returns that are more than double the yield on 10-year U.S. government treasuries. After double-digit increases in commercial property prices in gateway cities over the last five years, many investors have been priced out of those markets and are seeking better opportunities in nongateway centers. NewOak, 485 Lexington Avenue, New York, NY Point of View 1

2 February 2015 READING THE TEXAS TEA LEAVES: WILL LENDERS ABANDON CMBS REFINANCINGS TIED TO THE ENERGY SECTOR? Exposure to Energy Tenants Beyond the high profile and core assets, there are several loans to watch, primarily because many of their tenants are concentrated in the energy sector. We expect service companies will be the first to bear the brunt of any cost cutbacks, with mid-size producers and drillers also looking to reduce expenses as they ride out the downturn. While a true assessment of the impact of sliding oil prices will not be seen until after the second quarter, a review of assets secured by loans that mature over the next three years identifies exposure to some key concentrations. Among the high profile loans are Houston Two and Three Allen Center as Devon Energy is a major tenant of both assets. The firm occupies 10% of Three Allen, which is secured by a $157 million loan that matures in 2016, and leases 52% of Three Allen Center, which is secured by a $191 million loan that matures in Devon also occupies 36% of Corporate Tower, which is located in Oklahoma City and is secured by a $13 million loan that matures in August Any expense reductions that include space consolidation could have an impact on these assets. The prospectus of Two Allen notes a reserve for re-leasing of Devon s space if the tenant departs. Northborough Tower, 98% occupied by Noble Energy, has an $18.8 million loan maturing in January Apache Corp. and SEM are the major tenants in Two Warren Place, a $36 million loan that matures in The loan was originated in 2011 and is about 50% occupied by energy-related companies. The $115 million CityWest Center loan matures in 2016 and is undergoing re-leasing activity following departure notices from Halliburton and BMC Software, which occupied about 90% of the space. Struggling Retail Assets Face New Challenges Lower energy costs are a boon for consumers, but in areas dominated by energy and energyrelated industries, the benefits of lower prices may not be enough to offset the impact of concentrated job losses. As a result, we can While a true assessment of the impact of sliding oil prices will not be seen until after the second quarter, a review of assets secured by loans that mature over the next three years identifies exposure to some key concentrations. expect struggling retail assets to face additional challenges in refinancing loans that mature over the next 14 months. The $30 million loan to Williams Trace Center in suburban Houston matures in July According to Trepp, recent financials show DSCR at 1.0x and 88% occupied. Arrowhead Mall in Muskogee, Okla., is secured by a $16.9 million loan that matures in March The center has lost its theater, which filed for Chapter 11 bankruptcy, and Sears recently announced that it was leaving the center. In addition, Collin Creek Mall in Denton, a suburb of Dallas, was caught up in the General Growth bankruptcy filing in 2009, and saw Dillard s depart last year. According to servicer notes from Trepp, the borrower has already stated that it cannot meet debt service and will default on the $58 million loan. Killeen Mall, in Killeen Texas, is secured by an $82 million loan, maturing in According to servicer notes from Trepp, occupancy has 2 Point of View NewOak, 485 Lexington Avenue, New York, NY

3 increased from 70% in 2009 to about 90% in With a debt yield of 8%, this asset is on the borderline of refinancability. The following table highlights several non-core assets secured by loans that mature over the next three years. Using debt yields as a preliminary screen for refinancability, there are several loans with current debt yields below 9%. (The 9% threshold does not apply to trophy assets and major CBD core assets that typically are attractive in the 5%-6% range. In addition, NewOak, 485 Lexington Avenue, New York, NY Point of View 3

4 February 2015 READING THE TEXAS TEA LEAVES: WILL LENDERS ABANDON CMBS REFINANCINGS TIED TO THE ENERGY SECTOR? some lenders are willing to finance good retail and multifamily assets in the 8% range.) Many of the loans fall below the $10 million mark, a key threshold that market participants believe will struggle to secure financing. While there has been an increase in the number of lenders targeting the $5 million to $10 million range, today s more conservative lending standards will cause many loans to fall short. In addition, any increase in interest rates will put additional pressure on the refinancing prospects. Boomtown Shakeout Across the Midland-Odessa and Laredo, which are located in the Permian Basin and Eagle Ford regions, respectively, approximately $139 million in loans mature through To date, most of the assets have been strong performers and all have debt yields that far exceed 9%, based on the most recent financials reported by Trepp. Williston, N.D., the home of the Bakken formation and the biggest beneficiary of the recent energy boom, has three assets that were originated in 2013 and mature in All of the loans are secured by multifamily assets and, depending on the extent of the oil market slump, are most susceptible to default. Moreover, the $30 million Roosevelt Apartment loan was built for individuals and corporate tenants of ND Contract Services, Bakken Contracting and RHR Construction, according to the deal s prospectus. It is very likely that 4 Point of View NewOak, 485 Lexington Avenue, New York, NY

5 residential home construction, home sales, and construction in general will be delayed in the short term in North Dakota, where the firms have business concentrations. Over the past two years, some $114 million of loans secured by multifamily and hotel assets in the Williston area were pooled in CMBS 2.0 and 3.0 transactions. Any prolonged downturn that results in a halt or slowdown in drilling operations will cause these assets to struggle to service their debt. Watching the Lodging Sector The hospitality industry will provide the first indications of stress. Performance to date is strong, and there are few hotel loans that need refinancing in the next year or so. In Williston, some 1,200 rooms have come online since 2010, and the ability of the market to absorb all of this supply in the face of declining energy prices and an ensuing drop-off in business demand will be a challenge. We believe that the next six months will be an indicator of the impact on revenues and net operating income. But Liquidity Abounds While the outlook may seem uncertain in the short-term for refinancings in the sector, there is significant liquidity available in the property markets. Unlike the 1980s when much of the capital for property financing was centered in the regional banking sector, today s capital flows are global. Over the past five years, CRE investments were concentrated in gateway cities, which drove prices in those markets. While still attractive to global investors, many have begun looking elsewhere for better returns. And it is here that energy sector refinancings may find some support. We expect that many of the assets may turn to bridge loans to ride out any short-term instability; and over the long term, the more patient capital will take advantage of any value degradation and benefit from increases in values by the end of the decade. NewOak is built for today s global financial markets. Powered by an experienced team of independent cross-asset class and structured products experts, NewOak s financial advisory services, litigation consulting and credit services help our clients surmount the unique and demanding challenges in risk, credit, valuation and regulatory compliance, enabling them to maximize efficiencies internally and outperform externally. Backed by leading-edge analytics and financial technology solutions, NewOak s veteran market practitioners and legal professionals collaborate with clients to convert complex business threats into competitive advantage. Every day. For more information on our mortgage credit and compliance services or other NewOak financial advisory services and areas of asset expertise, please contact: Fergus Reid/head of marketing/ /freid@newoak.com Visit our website at NewOak, 485 Lexington Avenue, New York, NY Point of View 5