2007 Calgary Real Estate Forum Wednesday, October 24, 2007 Session - - PowerPoint PPT Presentation

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

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Where We Were Before the Recent Credit Market “Crunch”

Strong economic conditions Low interest rates and risk premiums (i.e. spreads) Attractive financing markets for borrowers Ever increasing size of private equity transactions U.S. sub-prime difficulties in remission after winter flare up Liquidity everywhere (CDOs, CMBS…)

100 200 300 400 500 600 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 10-Yr AAA/BBB Cdn CMBS Spreads (bps) 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% GoC Yield

10 Yr GoC Yield 10-Yr AAA Cdn CMBS Spreads 10-Yr BBB Cdn CMBS Spreads

10-Yr Cdn CMBS Spreads and GoC Yields: June 2001 to June 2007

$0 $40 $80 $120 $160 $200

1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07

US$ Billions

Institutional Com m ercial Banks

Leveraged Loan Issuance

Source: RBC Capital Markets Source: RBC Capital Markets

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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

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Starting in June 2007, the Canadian credit markets were “infected” by the universal symptoms of the larger “credit crunch”

► Spread widening across the board (CMBS/ABS, corporates, mortgages, etc.) ► Diminished liquidity / transaction volume

These trouble were a function of several factors including

► Contagion from the U.S. credit markets problems

– Sub-prime crisis / shut-down of the U.S. leverage lending market

► Liquidity concerns in Canadian non-bank sponsored ABCP market ($35B market)

– Began on Aug. 13, 2007 when Coventree was unable to repay its maturing ABCP

63 64 70 71 72 77 77 93 110 125 150 150 145 145 150 155 155 185 210 250 50 100 150 200 250 Jan- 07 Feb- 07 Mar- 07 Apr- 07 May- 07 Jun- 07 Jul- 07 Aug- 07 Sep- 07 Oct- 07 10-Yr AAA/BBB Cdn CMBS Spreads (bps)

10-Yr AAA Cdn CMBS Spreads 10-Yr BBB Cdn CMBS Spreads

10-Yr Cdn AAA and BBB CMBS Spreads: January 2007 to October 2007

$26 $43 $32 $47 $4 $2 $10 $7

$0 $10 $20 $30 $40 $50 $60 2005 2006 2007 June YTD 2007 Oct YTD CS$ Billions

Corporate Net Issuance ABS Net Issuance

Canadian Corporate and ABS Net Issuance

Source: RBC Capital Markets Source: RBC Capital Markets

Impact of Credit Market Crunch Broader Canadian Credit Markets

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Credit market turmoil also spilled into the real estate sector Significant widening of CMBS securities has resulted in

► CMBS lenders now quoting spreads around 200 bps ► Some non-CMBS lenders have taken advantage of this and widened spreads by as much as 50 bps

– Anecdotal evidence that tight spreads still exist

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

Impact of Credit Market Crunch Canadian Mortgage Pricing

GoC Bond Yields and Mortgage Rates

3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 5-yr GoC 10-yr GoC Mortgage 5 Yr. Mortgage 10 Yr.

Source: RBC Capital Markets

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Unsecured Debt Issuance While there was no new issuance in the Canadian REIT unsecured debt market from June to August, there have been 4 successful unsecured deals completed in the past 2 months, albeit at wider spreads than earlier in the year

► RioCan REIT, September 2007: $120 million, 5 years, 5.70% coupon (BBB(H), spread of 140bps) ► bcIMC – 2 deals

– 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

Impact of Credit Market Crunch Canadian Real Estate Unsecured Debt Issuance

$870 $950 $1,590 $790

$0 $300 $600 $900 $1,200 $1,500 $1,800 2004 2005 2006 2007YTD C$ Thousands

Canadian Real Estate Unsecured Debt Issuance

Source: RBC Capital Markets

5 Deals 13 Deals 7 Deals 6 Deals

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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