2007 Calgary Real Estate Forum Wednesday, October 24, 2007 – Session C3 Financing Strategies in an Increasing Volatile Environment: What Lies Ahead for CMBS, Capital Markets and Private Equity David Dulberg Managing Director RBC Capital Markets Real Estate Group
Where We Were Before the Recent Credit Market “Crunch” 10-Yr Cdn CMBS Spreads and GoC Yields: � Strong economic conditions June 2001 to June 2007 600 6.00% � Low interest rates and risk premiums 500 5.00% 10-Yr AAA/BBB Cdn CMBS (i.e. spreads) 400 4.00% Spreads (bps) GoC Yield � Attractive financing markets for 300 3.00% borrowers 200 2.00% � Ever increasing size of private equity 100 1.00% transactions 0 0.00% Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 � U.S. sub-prime difficulties in remission 10 Yr GoC Yield 10-Yr AAA Cdn CMBS Spreads after winter flare up 10-Yr BBB Cdn CMBS Spreads Source: RBC Capital Markets Leveraged Loan Issuance � Liquidity everywhere (CDOs, CMBS…) $200 $160 US$ Billions $120 $80 $40 $0 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 Institutional Com m ercial Banks 2 Source: RBC Capital Markets
Sub-Prime Crisis and Shut-Down of the U.S Leverage Lending Market U.S. Sub-prime Crisis � Crisis exacerbated by three major issues ► Factors including separation of origination and ownership led to lower underwriting standards ► Recent major reduction in housing prices and defaults have been near record levels ► Complex and non-transparent CDOs (which were a major source of financing for sub-prime lenders) Leverage Lending Market Shut-Down in the U.S. ► Private equity in “golden age” – In each of 2005 and 2006, more private equity raised than ten years preceding 2005 – Most of 20 largest private equity deals in history done in first 6 months of 2007 ► Increasing reliance on credit CDO structures to fund LBOs ► In the wake of the sub-prime crisis, leveraged finance markets experienced – A substantial re-pricing of risk (in the face of increased volatility) – Falling secondary prices – Greater scrutiny of deal structures – Heightened risk sensitivity among investors ► Investors pushed back on the massive leveraged loan pipeline of underwritten deals – Banks and investment banks holding US$300 billion of paper to be sold 3
Impact of Credit Market Crunch Broader Canadian Credit Markets 10-Yr Cdn AAA and BBB CMBS Spreads: � Starting in June 2007, the Canadian credit January 2007 to October 2007 markets were “infected” by the universal 250 250 10-Yr AAA/BBB Cdn CMBS Spreads symptoms of the larger “credit crunch” 210 185 200 ► Spread widening across the board 155 155 150 150 150 (CMBS/ABS, corporates, mortgages, etc.) 145 145 (bps) 150 125 110 ► Diminished liquidity / transaction volume 93 100 77 77 71 72 70 63 64 � These trouble were a function of several factors including 50 Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- 07 07 07 07 07 07 07 07 07 07 ► Contagion from the U.S. credit markets 10-Yr AAA Cdn CMBS Spreads 10-Yr BBB Cdn CMBS Spreads problems Source: RBC Capital Markets Canadian Corporate and ABS Net Issuance – Sub-prime crisis / shut-down of the U.S. leverage lending market $60 $10 $4 $50 ► Liquidity concerns in Canadian non-bank CS$ Billions $40 $2 $7 sponsored ABCP market ($35B market) $30 $47 $43 $20 – Began on Aug. 13, 2007 when Coventree $32 $26 $10 was unable to repay its maturing ABCP $0 2005 2006 2007 June YTD 2007 Oct YTD Corporate Net Issuance ABS Net Issuance 4 Source: RBC Capital Markets
Impact of Credit Market Crunch Canadian Mortgage Pricing � Credit market turmoil also spilled into the real GoC Bond Yields and Mortgage Rates estate sector 9.00% � Significant widening of CMBS securities has 8.00% resulted in 7.00% ► CMBS lenders now quoting spreads around 200 bps 6.00% 5.00% ► Some non-CMBS lenders have taken advantage of this and widened spreads by as 4.00% much as 50 bps 3.00% Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 – Anecdotal evidence that tight spreads still exist 5-yr GoC 10-yr GoC Mortgage 5 Yr. Mortgage 10 Yr. Source: RBC Capital Markets � Traditional mortgage lenders are placing greater scrutiny and emphasis on underwriting and risk tolerance, resulting in more conservative lending parameters, a current reduction in debt availability and increased spreads 5
Impact of Credit Market Crunch Canadian Real Estate Unsecured Debt Issuance Unsecured Debt Issuance Canadian Real Estate Unsecured Debt Issuance � While there was no new issuance in the 13 Deals Canadian REIT unsecured debt market from $1,800 $1,590 June to August, there have been 4 successful $1,500 unsecured deals completed in the past 2 7 6 Deals C$ Thousands $1,200 5 months, albeit at wider spreads than earlier in Deals Deals $950 $870 the year $900 $790 ► RioCan REIT, September 2007: $120 $600 million, 5 years, 5.70% coupon (BBB(H), $300 spread of 140bps) $0 ► bcIMC – 2 deals 2004 2005 2006 2007YTD Source: RBC Capital Markets – September 2007: $250 million, 5 years, 5.25% coupon (AA, spread of 100bps) – September 2007: $200 million, 10 years, 5.65% coupon (AA, spread of 135bps) ► Summit REIT, October 2007: $100 million, 2 years, 5.60% coupon (BBB(H), spread of 150bps) � Liquidity and pricing is expected to return in 2008 6
What’s Next? � Liquidity returning ► Debt deals (of all kinds – CMBS/ABS, corporates, mortgages, etc.) are getting done � Underlying real estate collateral still supported by strong fundamentals ► Growth in rents and net operating income ► Reduction in vacancy levels ► Strong investment sales � Current lending environment should return to “normal” over the next 3 to 6 months ► 2008 lender programs just around the corner ► “Panic” is subsiding 7
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