• CMBS: Introduction
• Target CMBS Investments
• Example Super Senior CMBS Structure
• Capital Preservation
• Sourcing Target CMBS Investments
• Underwriting Process | Continual Surveillance
• CMBS Hold Strategy | Spread Compression Drivers
• Anticipated unlevered Returns & Fee Structure
• CMBS Management Team
• Appendix

• The ongoing credit market disruption has led many bond investors to liquidate their portfolios at discounts and others to withhold buying activity. Consequently, spreads in many credit products, including CMBS, have widened substantially on thin trading or in sympathy with synthetic indices (CMBX), well beyond that necessary to reflect commercial real estate credit fundamentals.
• The CMBS market has been painted with the same brush as other structured finance products. In strong contrast to US subprime product, however, the vast majority of commercial mortgages that collateralize CMBS have performed as expected. In fact, less than 3.5% of CMBS mortgages are currently delinquent. Fear, misperception, and a lack of liquidity have created a tremendous opportunity for sophisticated investors to uncover tremendous value.
• Opin’s Edge: In depth issuer specific knowledge of underwriting parameters, which allows Opin’s CMBS team to take advantage of the current technical market dislocation in the safest CMBS securitizations and obtain the highest risk adjusted return all while focused on capital preservation.
• Opin’s CMBS approach, as described herein, will be to use both our commercial real estate and capital markets expertise to conduct due diligence on the loans and real estate prior to purchase.

• Target Investments are fixed-rate CMBS bonds underwritten internally as real estate investments.
• The underlying collateral will be evaluated using proprietary internally developed collateral underwriting/valuation tools, rather than simply relying on rating agency methodology.
• These targeted fixed-rate investments will;
  • Carry either Mezzanine AAA (A-J), or AA ratings,
  • Have subordination (credit protection) levels generally ranging from 8.0% to 13.0%,
  • Encompass pools where Opin is extremely confident the collateral backing acquired bonds can sustain the most stressed scenario(s), and
  • Will allow for tremendous diversification across numerous fixed-rate CMBS issuances, consisting of hundreds (if not thousands) of underlying first mortgage liens, spread across all property types and geographically diverse across some of the best markets in the U.S.

• The senior-subordinate structure creates senior and junior interests in the underlying asset pool. Each tranche, from AM up to NR (as illustrated below), provides protection to (i.e., is subordinate to) each other tranche listed below it and receives protection from (i.e., is senior to) each other tranche listed above it. The structure requires that all principal payments, both scheduled and from recoveries on defaulted loans, be used to retire the most senior outstanding bond (starting from bottom

Given the illiquidity premium in the market (or lack of capital currently in the sector), there are multiple credit events that simultaneously occur prior to potential principal erosion on Opin’s CMBS capital investment(s). Below are examples of stressed scenarios that demonstrate what would need to occur at each respective investment level (N.B.: Opin’s CMBS strategy calls for vast diversification across many pools & tranches):

• AA (≈10% credit protection): Assumes dollar price average of approximately $0.30
  • 32.5% of an entire pool would need to be liquidated and experience an average loss severity of 35%. Currently only approximately 3.5% of loans are delinquent (not in default).
  • Assuming an average original loan-to-value of 70% and an average loss severity of 35% on the loan balance, the recovered proceeds would represent only 45.5% of the original value of the underlying real estate.

• Current Delinquencies (≤ 3.5%):
• Although some individual market analysts forecast a potential increase in delinquencies to approximately 4.0% (YE2009) and potentially 6.0% (YE2010) given the lack of new supply leading to a net run-off of outstanding CMBS, please note the following concept regarding the CMBS structure:
  • Even in a stressed scenario where one could assume 30+ day delinquencies increase to 10% and 60% of those would be liquidated (6.0% of the CMBS pool), at a drastic 50% loss severity (which far exceeds average levels experienced today of about 30% - 35%) the securitization pool would suffer only 3.0% principle loss, which is far below credit levels of Opin’s Investment positions (AAA A-J’s / AA’s, which average 8.0% - 13% protection).
  • This also assumes average results and does not incorporate any benefit attributable to Opin’s CMBS proprietary underwriting and credit selection process.

• Opin will pursue certain senior CMBS bonds from sellers that could include:
  • Investment banks that are reducing their inventory of bonds,
  • Small to midsize commercial banks that might be forced to liquidate their inventory of bonds for liquidity and regulatory capital purposes, and
  • REITs and private investors forced to sell into a market where spreads remain at or near historic wide levels
  • Insurance companies and Pension Funds
• In addition, Opin will bid off daily generated bid lists from a host of Broker/Dealers and/or Investment Banks.
  • Generally there is only a 24 hour period (or less) to bid on secondary market bonds; therefore, Opin has completed much of the due diligence in advance, allowing for an aggressive and timely acquisition strategy and optimum portfolio construction.

• Due Diligence materials including securitization tapes (Annex A’s), Pre-Sale reports, and term sheets have already been obtained in Opin’s CMBS database.
• The services of Trepp, LLC (see surveillance section) will be utilized to get the most recent pool level data from Master & Special Servicers.
  • In addition, the CMBS team utilizes long lasting relationships with the B-Piece Buyer / Special Servicing community to obtain real time property analytics.
• Data points from the securitization tapes (among other sources) are analyzed using a proprietary CMBS Relative Value Model (see next page).
• The CMBS Relative Value Model provides the overall characteristics of the pool as it relates to leverage, property quality, market strength, diversification, and how aggressively the issuer underwrote the underlying transaction(s).
• Opin carefully scrutinizes any loan which makes up more than 5.0% of the overall pool size (generally the top 5 loans), or as we see fit given the granular nature of some transactions.

• The Team’s CMBS Relative Value Model evaluates and compares collateral within various securitization pools to assist in purchasing CMBS bonds. The model includes 33 criteria points, which describe various aspects of the underlying collateral. The 33 criteria points are broken down into five subcategories: Property Grade, Market Grade, Leverage Grade, Diversity Grade, and Underwriting Grade. A score from “0” to “4” is applied to each of the 33 data points. A total score as well as subcategory average scores are provided to evaluate and compare the collateral within a securitization pool.
• Property Grade evaluates and compares the data points relating to the quality of the property or property type within a securitization pool. For example, the percentages of single tenant assets or hotel properties are considered as those assets generally experience higher volatility than other commercial real estate assets in today’s marketplace. Hence, a higher percentage of those assets would reduce the relative property grade of a securitization pool. Conversely, the percentage of acquisition financing and the percentage of loans located in States with non-judicial foreclosure laws would increase a pool’s property grade due to their impact on property quality from a lenders standpoint. Also, securitizations with a high percentage of retail properties will be negatively adjusted based on current economic conditions.
• Market Grade evaluates and compares the data relating to the quality of the geographical locations of the properties. The percent of assets located in tertiary markets and the percentage of assets located in a Moody’s “red” markets (evaluates supply and demand characteristics) are evaluated along with other relevant market statistics.
• Leverage is one of the most critical subcategories and subsequently has the greatest number of criteria points. Pool wide and “Top 10” loan-to-values, debt service coverages, and pool wide amortization are reviewed and compared. In addition, debt yields and a refinance test assuming a 9.5% constant (10% for hotels) are also calculated and evaluated.
• Diversity Grade evaluates and compares the diversification qualities of a securitization pool. Largest asset type and percentage of the “Top 10” are the two criteria points included.
• Underwriting Grade evaluates and compares how aggressively issuers underwrote the loans within a securitization pool. Even though line by line cash flow analysis is not available for public bond purchases, one can measure how aggressively issuers underwrote transactions by evaluating the pool average discrepancy between the underwritten NOI and most recent historical full year NOI. Although ideal for multifamily and hotel analysis this analysis is also helpful in evaluating all other commercial real estate assets. Comparing an issuer’s underwritten NOI (or budget) to actual historical performance highlights any gaps between realized historical performance and forward-looking estimates utilized to underwrite a given loan.

• Leverage Grade – Cap rate analysis:
  • Due to reduction and availability of leverage, commercial real estate values are expected to decrease. Trophy properties or properties that were valued at tight capitalization rates (sub 5.0%) will decrease in value more substantially. Assuming the widening of capitalization rates is generic, there is a more significant impact to value when a capitalization rate goes from 5.0% to 7.0% versus 7.0% to 9.0%. Please see below
    • A $1.0B securitization pool with an original average capitalization rate of 5.0% would experience an 28.6% reduction in value if the average capitalization rate rose to 7.0%. Assuming an original average of Loan-to- Value of 70%, the reduction in value would translate to a revised 97.9% Loan-to-Value
    • A $1.0B securitization pool with an original average capitalization rate of 7.0% would experience an 22.2% reduction in value if the average capitalization rate rose to 9.0%. Assuming an original average of Loan-to- Value of 70%, the reduction in value would translate to a revised 89.9% Loan-to-Value
  • Due to the above, Opin’s strategy calls for investment in pools with wider capitalization rates at the time of issuance.

• Investments will be closely monitored on a weekly basis to identify any potential issues with respect to the underlying collateral.
• Given the public nature of these bonds, a wealth of information is available from various sources. Opin subscribes to products and services provided by Trepp LLC (snapshot of high-level information below), a leading provider of CMBS and commercial mortgage information, analytics, and technology to the securities and investment management community. Among other things, Trepp provides all relevant information with respect to; (i) Credit enhancement levels, (ii) Loan delinquencies, (iii) Servicer watchlists, (iv) Servicer remittance reports, and (v) Specially serviced loans.

• The Opin CMBS strategy calls for the acquisition of securities with approximately 8-years of remaining maturity. Opin will employ an interest rate hedging strategy to enable the Investor to cash out prior to maturity and to accommodate investors with a 3 year investment period.
• Due to their liquid nature, CMBS may be readily sold on the secondary market prior to maturity; should market spreads compress, the investment would provide a higher IRR than projected.
  

• Industry veterans believe that at some point in the future, CMBS securitized debt lending will return in some form as it represents a transparent and efficient form of distribution and diversifier of risk; however, CMBS market yield spreads would need to compress for new CMBS origination to become viable once again.
  • Current yields on CMBS bonds would require issuers to price new mortgages at rates in excess of 11%, which are simply not viable for potential commercial borrowers (especially at much lower leverage levels)
  • One of the drivers of these high yields is illiquidity; it can be argued that this is a temporary technical dislocation unrelated to the underlying credit risk associated with commercial mortgages
• The federal government has taken steps to revitalize the securitization markets and strengthen bank balance sheets, which to-date have proven to be successful. CMBS spreads should continue to tighten quite rapidly with greater numbers of investors occupying the space. Current federal initiative include:
  • PPIP (Legacy Securities Program)
  • TALF
  • Revision to Mark-to-market accounting rules

• The Manager receives a 2% management fee paid monthly.
• The investor receives a preferred 9% monthlly cash return in each and every month prior to the Manager receiving any management fee or participation payment. At conclusion of the investment, the investor receives a preferred 15% IRR before the Manager participates in the capital gain.

For the last two and a half years Greg has been Chief Underwriter (Executive Director) of the CMBS Mortgage Banking business at Eurohypo AG, where he was most recently honored as one of Institutional Investor News’ 20 Rising Stars of Real Estate (2008). At Eurohypo he managed the CMBS book, and structured, quoted, and priced large loans, floating rate transactions, conduit loans, and mezzanine loans for originators based in New York, Chicago, and Los Angeles. Key responsibilities included presenting transactions and deal structures to B-piece buyers and rating agencies. At Eurohypo he successfully securitized over $4.0B in commercial mortgages through nine (9) separate pools. In 2007 alone he took over 65 transactions from the quoting stage to loan sale, totaling to approximately $2.76B. Prior to joining Eurohypo he spent 7 years as a Director in Deutsche Bank’s CMBS Group, where he structured and completed loan underwriting due diligence on over $2.6B in commercial mortgages slated for CMBS securitization, including over $1.0B in 2005, $600MM in 2004, and $400MM in 2003. Greg received a BS in Finance & International Business from New York University’s Stern School of Business. He is also a member of ULI, and YREP.

• A typical Commercial Mortgage Backed Security (“CMBS”) is formed when an issuer/loan seller deposits commercial mortgage loans into a trust.. The issuer then passes information of those loans into rating agencies, and rating agencies create a series of tranches (bonds) backed by the loans, which form the senior-subordinated debt structure.
• The tranches have varying credit qualities from AAA, AA (senior tranche), to BB, B (subordinated) and to unrated (first loss) given that any return of principal generated by amortization, prepayment and default/liquidation is allocated to the highest-rated tranche first and then the lower-rated tranches, while any losses that arise from a loan default is charged against the principal balance of the lowest-rated tranche that is outstanding (first loss piece). Any interest received from outstanding principal is paid to all tranches, with any shortfall being allocated to the most subordinate tranche.
• For each CMBS tranche, subordination level is defined as the proportion of principal outstanding of other tranches with lower rating. It reflects “credit support” of that tranche. Rating agencies determine subordination levels at deal cutoff. Rating agencies independently examine how much subordination is needed for the tranches to reach certain ratings, such as AAA, AA, A, BBB etc. This forms the protective debt structure.
• Once the deal structure is finalized, rating agencies provide their credit risk assessment – bond ratings for each CMBS tranche. CMBS investors rely on the quality certification given by rating agencies and tell credit quality differences between different tranches mainly by their ratings, but will ultimately value a given bond by relying on an independent evaluation of the credit risk associated with the given investment.

• Ratings: Assessment of the likelihood that the cash flows and recoveries from the collateral will be sufficient to pay the requirement of the security defined. Rating calculates credit risk – default and loss on the investor’s principal investment.
  • A rating should indicate its ability to withstand a particular strength of an economic downturn. For example, a AAA bond should be able to withstand a significant macro-economic stress.
  • Subordination (credit enhancement) = Frequency (Percentage of a pool) defaulting (and foreclosed) * Loss Severity.
    
    
• Waterfall Structure: Cash flow pay-out priority of a CMBS
  • Principal plus interest to the highest-rated tranches, while paying only interest to the lower-rated tranches.
  • After all of the certificates from the highest-rated tranches have been retired, the cash flow then is dedicated to paying P&I to the next highest rated tranche.
  • Principal is paid in sequence until each successively-rated tranche receives payment; thus, for example, the most senior AAA tranche is retired prior to the Junior AAA Mezzanine tranche, etc.

The contents of this website are intended for sophisticated and institutional investors or their advisors. Opin Partners, LLC is not registered with the SEC, FSA or any other government agency as an advisor or manager. Nothing contained in this website should be construed as investment advice or as a security or an offer to sell or purchase an interest in a security.