The Future Refinancing Crisis in Commercial Real Estate: CMBS Research

Securitization
North America United States
15 July 2009
Special Report
CMBS Research Research Team
The Future Refinancing Crisis Richard Parkus

Global Markets Research
Research Analyst
(+1) 212 250-6724
in Commercial Real Estate richard.parkus@db.com
Jing An, CFA

Research Analyst
(+1 ) 212 250-5893
jing.an@db.com
Part II: Extensions and Refinements

Securitization
Deutsche Bank Securities Inc.

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factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research
is available to customers of DBSI in the United States at no cost. Customers can access IR at
http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1. MICA(P) 106/05/2009
15 July 2009 CMBS Research
Table of Contents
I. Introduction............................................................................................................................ 3
II. Review of the Methodology and Previous Results ............................................................... 5
III. Introduction of Term Defaults and Its Impact on the Results............................................. 11
IV. A More Detailed Analysis of Non-Refinanceable Loans..................................................... 17
V. A Look at Commercial Real Estate Problems in Bank Portfolios......................................... 23
V. Conclusions ........................................................................................................................ 28
Page 2 Deutsche Bank Securities Inc.

I. Introduction
This report is a follow-up to a previous report “The Future Refinancing Crisis in Commercial
Real Estate”, published April 23rd, 2009. That analysis applied a quantitative framework to
explore the magnitude of potential refinancing problems faced by the commercial real estate
debt markets over the coming decade. In particular, the analysis sought to answer the
following question: Assuming that all currently outstanding (and non-defeased) commercial
mortgages in CMBS deals reach maturity without defaulting, what proportion would qualify
to refinance. 1 The startling conclusion was that, under reasonable assumptions, an
extraordinarily large proportion of loans, perhaps 65%, or more, might well fail to qualify to
refinance, at least without large equity infusions. In effect, the massive paradigm shift in
underwriting standards, combined with 35-45% price declines and severely depressed cash
flows, would likely strand a vast swath of the commercial real estate debt markets.
The current analysis both refines and extends the results of the original report. The most
significant extension is the introduction of term defaults: both term (i.e. loan defaults
occurring prior to maturity) and maturity defaults are now treated simultaneously in an
internally consistent manner. This, of course, has a huge impact on maturity defaults, as
many loans that, in the previous analysis, were projected to default at maturity, do not
survive until maturity, in the current analysis, but rather default at some point prior to maturity
due to severe cash flow stress. Thus, a large proportion of the previously projected maturity
defaults become term defaults in the new analysis. This, in turn, has a major effect on both
the magnitude and timing of losses, and hence on valuations.
We estimate that:
• Total losses, the sum of term and maturity default related losses, on the outstanding
CMBS universe will be in the 9-12% range
• Total losses on the 2005-2008 vintages will be 11.6-15.3%
• Total losses on the 2007 vintage will exceed 21%
These loss rates are well above those experienced by life company portfolios during the early
1990s.
Modeling both term and maturity defaults provides a much clearer picture of the timing of
defaults and losses. It is also useful in providing a time frame for when distressed real estate
is likely to hit the market. This is particularly relevant as one of the main goals of the analysis
is to provide a “road map” for the types, magnitudes and timing of distressed opportunities
likely to be available within the commercial real estate market. The objective is to help
encourage the entry of private capital into the sector. We regard the entry of private capital
into commercial real estate as a critical step in dealing with the problems that, without
question, lies ahead over the next five year, or more.
The report also addresses, in some detail, commercial real estate loans in bank portfolios,
and the risk they pose both to the banks and the commercial real estate sector more
generally. It is shown that bank exposures to both construction and core commercial real
estate loans are very large, but grow alarmingly as one moves from large money center
banks to smaller regional and community banks. The performance of both construction and
core commercial real estate loans is also examined and compared to that of loans in CMBS
pools. Delinquency rates are surging among construction loans, having already reached the
1
By “qualify to refinance” we mean qualify for a loan sufficiently large to retire the current outstanding loan.
Deutsche Bank Securities Inc. Page 3

mid teens. Yet, we believe that the actual performance of construction loans is far worse
than current delinquency rates suggest due to presence of interest reserves. We expect that
ultimate losses on construction loans will be disastrously high.
We also expect that losses on core commercial real estate loans in bank portfolios will be at
least as large as those in CMBS pools. Moreover, the fact that delinquency rates on core
commercial real estate loans have consistently been two- to three-times that on CMBS loans
over the past three years, lends support to this view. Finally, it appears that banks are far
behind in terms of taking adequate charge offs for their problem real estate loan portfolios.
We believe that the manner in which regulators deal with problems in banks commercial real
estate loan portfolios will have a significant impact on the commercial real estate market
more generally.
The structure of this report is as follows: Section II reviews the quantitative methodology we
employ for estimating term and maturity default related losses, as well as our basic
assumptions. A variety of updated results on the proportion of loans likely to have difficulty
refinancing are also presented. Section III presents results on both term and maturity default
related losses, and their timing. How the introduction of term defaults changes the basic
picture of expected refinancing problems is explored. Section IV examines more deeply the
problem of non-refinanceable loans. In particular, we draw a distinction between those that
are potentially salvageable and those that are not. The scale of potential opportunities for
private capital in commercial real estate is also examined. In Section V, the risks of
commercial real estate loans in bank portfolios are examined in detail.

II. Review of the Methodology and Previous Results

This section reviews the quantitative methodology on which the analysis of commercial
mortgages in CMBS deals is based. Updated versions of the results on refinanceability and
maturity default-related losses, from the original report, are then presented in order to
provide a context for the new results, which are presented in the following sections.
The quantitative analysis is based on the entire outstanding (non-defeased) fixed rate conduit
sector of CMBS, comprising in excess of 54,000 loans with an aggregate balance of
approximately $625 billion.2 The first step is to project NOI for ten years for each individual
loan on the basis of the type of property securing the loan and the MSA in which it is located.
The projections are based in part on MSA/property type forecasts produced by Property and
Portfolio Research (PPR). PPR produces five year forecasts of rents, vacancy rates and NOI.
The analysis employs PPR’s forecasts for the first five-year period. For the second five-year
period, it is assumed that NOI returns linearly to its Q3 2008 level by the end of year ten.
These NOI projections are then run through Intex’s loan-level cash flow models. For each
loan, the value of the underlying property(s) is estimated by applying a cap rate to projected
cash flows. This allespows for the calculation of an approximate LTV and DSCR at each point
in time. Finally, assumptions are made about the maximum LTV, minimum DSCR and future
financing costs (i.e. the future mortgage rates).
The above NOI projections and refinancing assumptions form the inputs to the term and
maturity default models, and allows for estimates of term losses, refinanceability, and
maturity related losses.
The analysis employs two different NOI projection scenarios, the Severe Stress Scenario and
the Moderate Stress Scenario. Each is based on a specific PPR projection scenario. The
Severe Stress Scenario is the “base case” scenario for the analysis. The approximate degree
of stress in each of the two scenarios is summarized in Figure 1. For each property type, the
average (across MSAs) of the maximum percentage decline in NOI starting from Q3 2008 is
reported.
Figure 1: Degrees of Stress in the Two NOI Projection Scenarios
Average of Maximum NOI Declines Across MSAs
Property Type Severe Recession Scenario* Moderate Recession Scenario **

Industrial -16.3 -7.5
Multifamily -15.0 -8.9
Office -32.6 -12.4
Retail -26.6 -21.5
Hotel *** -20.0 -20.0
* PPR's "Severe Recesion Scenario" as of Q3 2008

** PPR's "Deep Recession Scenario Fast Recovery" as of Q4 2008
*** Hotel projection not based on PPR projections
Source: Deutsche Bank and Property and Portfolio Research
There are two final comments about the NOI projections. First, NOI projections for hotels are
not based on PPR forecasts. We simply assume that for each hotel NOI declines by 20%
through the end of 2012 and then increases back to its Q3 2008 level by 2018. In view of
2
When a loan is defeased, the borrower delivers to the trustee a portfolio of agency and US Treasury debt that
replicates the required payments of the loan in exchange for release of the securing property. Defeased loans have
neither credit nor refinance risk, and thus are excluded from this analysis.

recent performance data, this is clearly too small of a decline. According to Smith Travel
Research, hotel RevPAR is already down 20% in the aggregate across chain scale categories,
and this would translate into declines in NOI that are much larger than 20%, particularly in
view of hotel’s high operating leverage. The results of this can be seen in the next section,
where total losses for hotels, including both term and maturity default related losses are
projected to be only 5.5%. That this is far too low can be seen clearly in the recent
delinquency data: hotel delinquency rates, as of June stood at 4.32%, up almost 300% in
only four months.
Second, as noted above, it is assumed that NOI follows the PPR projections for the first five
years, after which it returns to its Q3 2008 level in year ten. This, of course, implies a 10-year
cumulative average growth rate (CAGR) of 0%. While this may appear to be a harsh
assumption on the surface, in reality it is not. For example, average office NOI needs to grow
by nearly 50% over the second five-year period to get back to its Q3 2008 starting point. This
represents an extraordinarily fast pace of growth for NOI.
Figure 2 summarizes the cap rates used in the analysis. The cap rates are assumed to decline
modestly after five years. The corresponding debt yield, assuming a 70 LTV, is also given.3
Figure 2: Assumed Cap Rates for Projections

Months Months Months Months
Property Type 0-24 24-60 60-120 120-240 Debt Yield **
Industrial 8.5 8.5 8.0 8.0 11.5 - 12.5
Multifamily 8.0 8.0 8.0 8.0 11.5
Office 8.5 8.5 8.0 8.0 11.5 - 12.5
Retail 8.5 8.5 8.0 8.0 11.5 - 12.5
Hotel * 9.0 9.0 8.0 8.0 11.5 - 13.0
* Hotel projection not based on PPR projections

** Debt yield at maximum at LTV of 70
Source: Deutsche Bank
Finally, the following refinancing assumptions are employed to test for refinanceability:
• Mortgage rate: 8%
• Maximum LTV: 70
• Minimum DSCR: 1.3x
Before proceeding, it will be helpful for understanding the non-refinanceability and maturity
loss results, to know the amount of loans from each historical CMBS vintage that are
scheduled to mature in each year over the coming decade. This information is summarized in
Figure 3, which is reprinted from the previous report.
3
The concept of a debt yield, defined as the NOI divided by the loan amount has gained in popularity recently.

Figure 3: Maturity Profile of Fixed Rate Conduit Commercial Mortgages in CMBS Transactions
Loan Vintage
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
160
150
140
Balance of Maturing Loans ($bn)
130
120
110
100
90
80
70
60
50
40
30
20
10
0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: Deutsche Bank and Intex
The term and maturity default models have been refined since the publication of the original
report. The results for non-refinanceability and maturity default related losses, by maturity
year, are summarized in Figure 4 under the severe stress scenario and in Figure 5 under the
moderate stress scenario. Three categories are presented in Figures 4 and 5. The “Non-
Refinanceable” category reflects all loans that fail to qualify without equity infusions. The
“Non-Refinanceable Loans with Losses” category reflects those loans that do not qualify and
also experience a loss. Typically, these are loans having an LTV in excess of 90%. Note that a
loan with an 80% LTV would not qualify to refinance, but would also probably not lead to a
loss. The final category, “Maturity Default Losses”, simply reflects the losses from the loans
in the previous category. Thus, under the severe stress scenario, 72.5% of loans fail to
qualify to refinance, but only 45.2% of loans suffer losses. Total losses are 11.3%, or $70.1
billion. Under the moderate stress scenario, 64.4% of loans fail to qualify, while only 36.6%
suffer losses. Total losses are 9.0%, or $55.8 billion.
Under both stress scenarios, the maturity years with by far the highest maturity default
related loss rates are 2011, 2012 and 2017. This certainly makes intuitive sense, as 2011 and
2012 have high proportions of 5-year loans from the 2006 and 2007 vintages, respectively.
This can be seen in Figure 3. Moreover, 2017 loan maturities are almost exclusively from the
2007 vintage. This certainly suggests that the 5-year loans from the 2006 and 2007 vintages
are likely to suffer massive maturity default losses.
As expected, however, the largest dollar amounts of maturity default related losses occur in
years 2016 and 2017.

Figure 4: Non-Refinanceability and Maturity Default Related Losses by Maturity Year: Severe Stress Scenario
Non-Refinanceable Loans Maturity Default

Non-Refinanceable with Losses Losses
Maturity Maturities* Balance %** Balance %** Balance %**
Year ($ Billions) ($ Billions) ($ Billions) ($ Billions)
2009 17.5 8.2 46.9 3.6 20.6 1.1 6.2
2010 33.6 22.6 67.3 14.1 41.9 3.0 9.0
2011 43.6 31.6 72.4 21.1 48.5 5.8 13.4
2012 58.3 46.9 80.3 35.6 61.0 11.8 20.3
2013 42.4 29.3 69.0 16.1 37.9 4.3 10.2
2014 51.7 37.9 73.4 23.1 44.6 5.3 10.3
2015 98.7 68.8 69.7 38.8 39.3 7.7 7.8
2016 135.3 99.4 73.4 59.2 43.7 13.2 9.8
2017 135.8 104.4 76.9 69.6 51.3 17.7 13.0
2018 6.1 2.7 45.3 0.6 9.3 0.1 2.1
Total 623.1 451.9 72.5 281.8 45.2 70.1 11.3
* Excludes defeased loans
** Percent of current balance of scheduled maturities excluding defeased loans
Figure 5: Non-Refinanceability and Maturity Default Related Losses by Maturity Year: Moderate Stress Scenario
Non-Refinanceable Loans
Non-Refinanceable with Losses Maturity Default Losses
Maturity Maturities* Balance %** Balance %** Balance %**
Year ($ Billions) ($ Billions) ($ Billions) ($ Billions)
2009 17.5 7.7 44.2 3.0 17.3 0.9 5.3
2010 33.6 21.5 64.0 12.7 37.8 2.7 8.2
2011 43.6 28.7 65.8 18.4 42.2 4.8 11.1
2012 58.3 41.4 71.0 31.2 53.5 9.8 16.8
2013 42.4 21.2 50.0 10.5 24.8 2.8 6.5
2014 51.7 29.8 57.5 15.1 29.2 3.4 6.5
2015 98.7 58.4 59.2 25.7 26.1 5.1 5.2
2016 135.3 90.6 67.0 47.1 34.8 10.5 7.8
2017 135.8 99.4 73.2 63.8 47.0 15.6 11.5
2018 6.1 2.5 41.0 0.5 8.9 0.1 2.0
Total 623.1 401.2 64.4 228.1 36.6 55.8 9.0

The data in Figures 6 and 7 simply re-organize the results by origination vintage instead of
maturity year, a different stratification. (Note that the numbers are slightly different only
because we exclude the pre-2000 vintages from the figures.) The figures show the startling
degree to which the 2007 vintage is inferior to all preceding vintage, and even the 2008
vintage.

It should be kept in mind that in Figures 6 and 7 losses are calculated as a percentage of
current balances. Thus, for seasoned vintages which have experienced a great deal of
paydowns or defeasance, these loss rates will differ markedly from the more usual
calculation of total losses as a percentage of original balances.
Figure 6: Non-Refinanceability and Maturity Default Related Losses by Vintage: Severe Stress Scenario
Origination Maturities* Balance %** Balance %** Balance %**
Vintage ($ Billions) ($ Billions) ($ Billions) ($ Billions)
2000 10.9 4.7 42.9 1.7 15.5 0.5 5.0
2001 18.0 9.3 51.8 3.9 21.4 1.0 5.7
2002 19.5 11.3 58.1 5.4 27.5 1.2 6.1
2003 33.3 19.6 59.0 9.7 29.1 2.1 6.3
2004 54.3 36.5 67.3 19.3 35.4 3.8 7.0
2005 123.5 89.4 72.4 55.0 44.6 11.4 9.2
2006 158.9 117.5 73.9 71.2 44.8 16.0 10.1
2007 189.9 153.1 80.6 110.8 58.4 32.7 17.2
2008 10.7 6.6 62.2 3.5 33.2 0.9 8.2
2000 - 2008 618.9 448.1 72.4 280.5 38.3 69.6 9.5
2005 - 2008 482.9 366.6 75.9 240.6 48.0 61.0 12.2

Figure 7: Non-Refinanceability and Maturity Default Related Losses by Vintage: Moderate Stress Scenario
Origination Maturities* Balance %** Balance %** Balance %**
2000 10.9 4.2 38.9 1.4 12.8 0.5 4.7
2001 18.0 7.7 42.7 3.1 17.0 0.9 4.8
2002 19.5 8.3 42.6 3.0 15.4 0.8 4.2
2003 33.3 13.4 40.2 5.5 16.6 1.3 3.8
2004 54.3 27.4 50.5 11.5 21.1 2.3 4.2
2005 123.5 78.2 63.3 40.1 32.4 8.1 6.5
2006 158.9 106.9 67.3 56.5 35.5 12.4 7.8
2007 189.9 146.3 77.0 103.3 54.4 28.7 15.1
2008 10.7 6.1 56.8 3.1 28.7 0.7 6.7
2000 - 2008 618.9 398.4 64.4 227.4 36.7 55.5 9.0
2005 - 2008 482.9 337.4 69.9 202.9 42.0 49.8 10.3


Figure 8 re-expresses the projected maturity default related losses as a percentage of original
balance. Existing realized losses are also taken account of so that the results reflect projected
average lifetime performance of the vintages. Even though the weak vintages of 2006-2008
are expected to see very high losses, particularly by historical standards, the more seasoned
vintages are still expected to perform extremely well.
Figure 8: Expected Losses as % of Original Balance by Vintage for Severe and Moderate Stress Scenarios
Severe Stress Moderate Stress

Scenario Scenario
Existing Losses Projected Losses Projected Losses

Original Balance Balance %* Balance %* Balance %*
2000 27.9 0.4 1.6 0.5 1.9 0.5 1.8
2001 37.0 0.4 1.1 1.0 2.8 0.9 2.3
2002 34.8 0.2 0.5 1.2 3.4 0.8 2.3
2003 54.7 0.1 0.2 2.1 3.8 1.3 2.3
2004 74.5 0.1 0.1 3.8 5.1 2.3 3.0
2005 137.1 0.1 0.1 11.4 8.3 8.1 5.9
2006 162.8 0.0 0.0 16.0 9.8 12.4 7.6
2007 190.9 0.0 0.0 32.7 17.1 28.7 15.0
2008 10.7 0.0 0.0 0.9 8.2 0.7 6.6
Total 730.6 1.3 0.2 69.6 9.5 55.5 7.6
* Percentage of original balance

III. Introduction of Term Defaults and Its Impact on the Results

In this section the results of the original report are extended by adding term defaults into the
analysis. The triggers for term defaults and maturity defaults are quite different. Term
defaults are triggered by cash flow stress when there is negative equity in the deal. In
particular, it is assumed that in the presence of negative equity, the borrower will continue to
make the mortgage payments as long as the property generates sufficient cash flow to cover
debt service. However, as the DSCR declines sufficiently below 1.0x for a sufficiently long
period of time, the borrower chooses to default rather than carry the property. The trigger for
a maturity default, on the other hand, is related more to refinanceability. Inability to refinance
at maturity when there is little or no equity leads to borrowers to opt for maturity default.
Adding term defaults will certainly reduce projected maturity defaults and losses to some
degree as some proportion of the loans that previously defaulted at maturity now default
prior to maturity. However, there are also loans that previously did not default at maturity that
do, in the current analysis, experience a term default. As a result, the total number (and
balance) of loans that default is significantly higher than before.
Figure 9 presents, for the Severe Stress Scenario, projected term defaults and term losses,
projected maturity defaults and maturity losses and existing losses, all by origination vintage.
These are combined to arrive at estimated total default rates and total loss rates. All rates are
with respect to original balances, thus these numbers reflect projected lifetime performance.
Figure 10 reports the analogous results for the Moderate Stress Scenario.
Figure 9: Projected Term, Maturity and Total Loss Rates by Origination Vintage: Severe Stress Scenario
Projected Term Projected Maturity Existing Projected Total
Origination Default Loss Severity Default Loss Severity Loss Default Loss
Vintage (%)* (%)* (%)* (%)* (%)* (%)* (%)* (%)* (%)*
2000 2.6 1.4 52.3 4.3 0.9 21.9 1.6 6.9 3.9
2001 2.5 1.2 48.7 8.5 1.9 21.9 1.1 11.1 4.2
2002 3.1 1.4 46.0 12.9 2.2 17.2 0.5 16.0 4.2
2003 4.0 1.9 47.4 14.1 2.2 15.5 0.2 18.2 4.3
2004 6.5 2.9 44.8 20.6 3.0 14.7 0.1 27.1 6.0
2005 8.7 4.2 48.6 32.5 5.5 16.9 0.1 41.2 9.8
2006 14.7 7.4 50.3 31.0 5.5 17.9 0.0 45.6 12.9
2007 21.7 12.1 55.8 38.4 9.2 23.9 0.0 60.0 21.3
2008 17.7 8.5 47.9 19.8 5.7 28.7 0.0 37.5 14.2
2000-2008 12.2 6.3 52.2 27.7 5.5 19.7 0.2 39.8 12.0
2005-2008 15.8 8.3 52.9 34.0 6.9 20.3 0.0 49.7 15.3
* Percent calculated with respect to original balance
The average loss rate for the 2000-2008 vintages is projected to be 12% under the Severe
Stress Scenario. This is split fairly evenly between term loss rate (6.3%) and maturity loss
rate (5.5%). For the problem vintages, 2005-2008, the total loss rate is 15.3%. Loss rates for
the seasoned pre-2005 vintages are higher when we model term defaults, but they remain
quite good overall. The 2007 vintage is projected to suffer a staggering 21.3% total loss rate.
Average loss severity rates are also reported. Loss severity rates are much higher for term
defaults (52%) than for maturity defaults (20%), which accords well with what is actually
observed in practice. It is worth noting that loss severity rates are outcomes of the models,
not inputs.

Figure 10: Projected Term, Maturity and Total Loss Rates by Origination Vintage: Moderate Stress Scenario

Origination Default Loss Severity Default Loss Severity Loss Default Loss
Vintage (%)* (%)* (%)* (%)* (%)* (%)* (%)* (%)* (%)*
2000 2.7 1.4 52.9 3.3 0.8 24.7 1.6 6.0 3.8
2001 3.4 1.5 44.7 5.6 1.2 21.2 1.1 9.0 3.8
2002 3.6 1.6 45.2 5.7 1.0 18.2 0.5 9.3 3.2
2003 3.2 1.5 48.9 7.5 1.1 14.2 0.2 10.6 2.8
2004 4.1 1.9 46.4 12.5 1.8 14.5 0.1 16.6 3.8
2005 5.6 2.8 49.7 24.6 4.0 16.3 0.1 30.2 6.8
2006 8.3 4.3 52.3 27.9 4.9 17.4 0.0 36.2 9.2
2007 15.0 8.4 56.3 40.3 8.7 21.7 0.0 55.3 17.2
2008 11.4 5.4 47.1 23.2 4.8 20.8 0.0 34.5 10.2
2000-2008 8.1 4.3 53.1 24.2 4.6 19.0 0.2 32.3 9.1
2005-2008 10.2 5.5 54.0 31.6 6.1 19.3 0.0 41.8 11.6
* Percent calculated with respect to original balance
The results under the Moderate Stress Scenario are qualitatively similar to those of the
Severe Stress Scenario. These two scenarios project that total conduit CMBS loss rates to be
in the 9-12% range for the 2000-2008 vintages, and 17-21% range for the 2007 vintage.
Figures 11 and 12 present the same information as in Figures 9 and 10, except that it is
presented in terms of dollar amount instead of percentages of original balances. Total losses
are projected to be between $66 billion and $88 billion. Total defaults are projected at $235 -
$290 billion.
Figure 11: Projected Term, Maturity and Total Loss Amounts by Origination Vintage: Severe Stress Scenario
Origination Default Loss Default Loss Loss Default Loss

Vintage ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions)
2000 0.7 0.4 1.2 0.3 0.44 1.9 1.1
2001 0.9 0.5 3.2 0.7 0.39 4.1 1.5
2002 1.1 0.5 4.5 0.8 0.18 5.6 1.4
2003 2.2 1.0 7.7 1.2 0.09 9.9 2.3
2004 4.8 2.2 15.4 2.3 0.09 20.2 4.5
2005 11.9 5.8 44.5 7.5 0.08 56.5 13.4
2006 23.9 12.0 50.4 9.0 0.04 74.3 21.1
2007 41.4 23.1 73.2 17.5 0.01 114.6 40.6
2008 1.9 0.9 2.1 0.6 0.00 4.0 1.5
2000-2008 88.8 46.4 202.3 39.8 1.32 291.1 87.5
2005-2008 79.1 41.8 170.3 34.7 0.13 249.4 76.6

Figure 12: Projected Term, Maturity and Total Loss Amounts by Origination Vintage: Moderate Stress Scenario
Origination Default Loss Default Loss Loss Default Loss
Vintage ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions)
2000 0.7 0.4 0.9 0.2 0.44 1.7 1.1
2001 1.3 0.6 2.1 0.4 0.39 3.3 1.4
2002 1.3 0.6 2.0 0.4 0.18 3.3 1.1
2003 1.7 0.8 4.1 0.6 0.09 5.8 1.5
2004 3.0 1.4 9.3 1.3 0.09 12.4 2.9
2005 7.6 3.8 33.7 5.5 0.08 41.3 9.4
2006 13.5 7.1 45.5 7.9 0.04 59.0 15.0
2007 28.6 16.1 77.0 16.7 0.01 105.6 32.8
2008 1.2 0.6 2.5 0.5 0.00 3.7 1.1
2000-2008 59.0 31.3 177.1 33.6 1.32 236.1 66.2
2005-2008 50.9 27.5 158.7 30.6 0.1 209.7 58.3
Finally, Figures 13 and 14 reorganize the data in Figures 11 and 12 to present losses in terms
of the year in which they occur. This gives important information about the projected timing
of losses.
Figure 13: Projected Term, Maturity and Total Loss Amounts by Year of Loss: Severe Stress Scenario
Projected Term Projected Maturity Projected Total

Default Loss Default Loss Default Loss
Year ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions)
2009 18.5 9.5 2.6 0.6 21.1 10.2
2010 2.6 1.4 13.4 2.7 16.0 4.1
2011 5.9 2.8 19.4 5.0 25.3 7.8
2012 51.9 27.1 32.4 10.2 84.3 37.3
2013 11.4 6.2 12.2 2.3 23.6 8.5
2014 0.3 0.2 17.8 3.1 18.1 3.3
2015 0.0 0.0 27.7 3.7 27.7 3.7
2016 0.0 0.0 36.8 5.6 36.8 5.6
2017 0.0 0.0 40.3 6.8 40.3 6.8
2018 0.0 0.0 0.2 0.1 0.2 0.1
Total 90.6 47.2 202.8 40.0 293.4 87.2

Figure 14: Projected Term, Maturity and Total Loss Amounts by Year of Loss: Moderate Stress Scenario

Default Loss Default Loss Default Loss
Year ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions) ($ Billions)
2009 19.3 10.0 2.3 0.6 21.6 10.6
2010 8.0 3.8 11.9 2.3 19.9 6.1
2011 14.2 7.6 15.9 3.8 30.1 11.3
2012 18.0 10.1 26.4 7.2 44.4 17.3
2013 0.9 0.5 7.8 1.3 8.7 1.8
2014 0.3 0.2 12.0 2.0 12.3 2.1
2015 0.0 0.0 19.3 2.6 19.3 2.6
2016 0.0 0.0 35.3 5.6 35.3 5.6
2017 0.0 0.0 46.1 8.2 46.1 8.2
2018 0.0 0.0 0.3 0.1 0.3 0.1
Total 60.6 32.1 177.3 33.7 238.0 65.8
The loss timing data in Figure 13 is presented visually in Figure 15. It is important to note that
in both the term and maturity default models losses are assumed to be realized immediately
upon default-- loss timing is really just default timing. This approach is taken, despite the fact
that in reality there is a long lag between defaults and loss realization (typically 18-24
months), in order to account for appraisal reductions, which are critical in valuing CMBS
securities.4
Interestingly, maturity default related losses build quickly from 2010 and peak in 2012, not in
2017. This reflects the fact that 2012 is projected to be the trough of the downturn.
Term losses, however, are concentrated in the 2009-2013 time period. The loss timing looks
a bit odd because, by design, the term default/loss is taken at that point along the NOI
projection that produces the greatest loss. This typically occurs close to 2012, since this is
where the maximum decline in NOI takes place. The large losses in 2009 reflect the fact that
the model immediately defaults all loans that are currently 60-days delinquent or worse.
4
From a cash flow and valuation perspective, appraisal reductions effectively shorten the time between defaults and
losses to just a few months.

Figure 15: Projected Timing of Term and Maturity Defaults/Losses
Term Losses Maturity Losses Total Losses

40
35
30
Losses ($ Billions)
25
20
15
10
0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Given that the models are projecting very large losses over the next five years, one naturally
wonders about the consistency of current loan performance trends with these projections. In
order to gauge this consistency, current delinquency data for fixed rate conduit loans can be
used. It turns out that simple delinquency rates are not of much use here, since loans can
remain in the 90+ day delinquency category for several years. What is needed is an
approximate current default rate for CMBS loans. This can be estimated by calculating the
annualized rate of flow of loans into the 90+ day delinquency category.5
The new 90+ day delinquency rate, the proxy for the default rate, is presented in Figure 16,
both for all outstanding loans (blue line) and for the 2007 vintage loans (black line). The data
suggests that for the CMBS universe as a whole, loans are now defaulting at a rate of
approximately 5.5% annually. If defaults remain at this level for two years and the loss
severity rate is 50%, then losses will reach the projected level of term losses. Turning next to
the 2007 vintage loans, the current default rate is about 8.5%. Were this pace to be
maintained for three years, with a loss severity, again, of 50%, losses would reach the 12%
projected rate for this vintage. Of course, in reality, we expect loan performance to continue
to deteriorate for the next 12-24 months. Therefore, we believe that these loss projections
are roughly consistent with the current loan performance data, at least for the moment.
5
In order to avoid double counting, i.e. loans that become 90+ days delinquent, cure and then become 90+ days
delinquent again at some point in the future being counted as two separate defaults, we exclude loans from the
calculation once they have become 90+ delinquent for the first time.

Figure 16: Approximate Annualized Default Rates for Both the CMBS Universe and the 2007 Vintage
Annualized Rate of new 90+ delinquency Annualized Rate of new 90+ delinquency - 2007 Vintage
9
7
Annualized Rate (%)
5
4
0
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09
Source: Deutsche Bank and Intex
Finally, Figure 17 presents projected term and maturity default related losses by property
type. Not surprisingly, office leads the way with nearly 22% projected total losses. Retail and
multifamily lag well behind with 13.9% and 15.1% projected losses, respectively. Clearly,
projected total loss rates for hotel loans, at 5.5%, are grossly inadequate.
Figure17: Projected Term and Maturity Default Related Losses by property Sector

Property Default Loss Default Loss Default Loss
Sector %* %* %* %* %* %*
Hotel 5.3 3.0 16.2 2.6 21.6 5.5
Industrial 4.5 2.1 18.1 2.3 22.6 4.4
Multifamily 14.3 7.2 36.9 7.9 51.2 15.1
Office 26.3 14.4 32.9 7.3 59.2 21.7
Retail 13.5 6.6 40.4 7.3 54.0 13.9
Multi-Property 8.9 4.9 35.6 8.0 44.5 12.9
Other 17.7 9.7 30.9 6.1 48.6 15.8
* Percent calculated with respect to balance at time of default

IV. A More Detailed Analysis of Non-Refinanceable Loans

The analysis has, until now, focused on defaults and losses of various types and the
proportion of loans that may not qualify for refinancing at maturity. This section takes a
somewhat different perspective of the problem by attempting to identify, in more detail,
when and where the opportunities for private capital may be in commercial real estate.
To begin with, loans that do not qualify to refinance are categorized into two groups. The first
group consists of loans that do not qualify to refinance, but could nevertheless potentially
escape foreclosure through the use of mezzanine financing or some type of equity
partnership. This group consists, roughly, of loans whose LTVs at maturity are below 100%.
(In reality it might be better approximated by loans with LTVs below 90-95%.) The second
group consists of loans that likely cannot be salvaged--loans with maturity LTVs in excess of
100%. These loans must, in the end, either be sold to distressed investors or foreclosed
upon and the properties liquidated.6 Thus, the first category of loans represents opportunities
for mezzanine finance and/or equity partnerships, while the second category represent
opportunities for distressed real estate or loan investors. While this breakdown is admittedly
crude, we believe it has some value in helping to refine the estimated magnitude of various
types of potential future opportunities.
Figures 18-21 use the above categorization to estimate the approximate size of these
opportunities over time. In particular, in Figure 18 it is assumed, once again, that there are no
term defaults, only maturity defaults. The aggregate balance of loans in each category, as
well as their equity deficiency, is presented for each maturity year, for both the Severe and
Moderate Stress Scenarios. Under the Severe Stress Scenario, $402 billion dollars of loans
are salvageable, while $180 billion are not. Under the Moderate Stress Scenario, $442 billion
are salvageable and $141 billion are not. The results suggest a need for approximately $35-
$40 billion in new equity or mezzanine financing in the case of salvageable loans.
It should be noted that in Figures 18-21 the aggregate balance is somewhat lower than in
previous figures. The reason is that the balances used are the balances either at maturity or
at the time of term default. They are not today’s current balances.
6
Discounted payoffs are another possibility.

Figure 18: Approximate Size and Equity Deficiency for Salvageable and Non-Salvageable Loans by Maturity Year:
Assuming No Term Defaults
Severe Scenario Moderate Scenario
LTV <=100 LTV > 100 LTV <=100 LTV > 100
Equity Equity Equity Equity
Maturity Balance Deficiency Balance Deficiency Balance Deficiency Balance Deficiency
Year ($ Bil) ($ Bil) ($ Bil) ($ Bil) ($ Bil) ($ Bil) ($ Bil) ($ Bil)
2009 15.6 0.9 2.5 1.2 17.2 0.7 2.0 1.0
2010 24.6 2.3 8.4 3.4 25.9 2.3 7.1 2.9
2011 28.7 2.7 13.9 6.6 31.1 2.6 11.5 5.4
2012 28.6 2.7 27.8 14.0 32.7 2.6 23.6 11.6
2013 29.0 2.4 10.1 4.8 33.3 1.9 5.9 2.9
2014 33.7 3.2 14.1 6.2 39.9 2.9 7.9 3.6
2015 68.9 6.6 20.2 8.7 76.0 5.3 13.1 5.7
2016 88.7 8.8 35.2 15.4 96.5 8.2 27.4 11.9
2017 80.3 7.8 47.1 21.3 85.1 7.7 42.3 18.9
2018 3.8 0.1 0.4 0.2 3.8 0.1 0.4 0.2
Total 401.9 37.4 179.6 81.9 441.5 34.3 141.3 64.1
Figure 19 simply reorganized the data in Figure 18 and presents in by origination vintage.
Figure 19: Approximate Size and Equity Deficiency for Salvageable and Non-Salvageable Loans by Vintage:
Assuming No Term Defaults
LTV <=100 LTV > 100 LTV <=100 LTV > 100
Vintage Balance Deficiency Balance Deficiency Balance Deficiency Balance Deficiency
2000 9.6 0.4 0.9 0.4 9.8 0.4 0.8 0.4
2001 15.2 1.0 1.9 0.9 15.6 0.8 1.5 0.7
2002 15.6 1.2 2.5 1.2 16.5 0.8 1.6 0.8
2003 25.1 2.0 5.1 2.2 27.6 1.4 2.6 1.2
2004 39.4 3.4 10.1 4.3 44.2 2.7 5.5 2.3
2005 82.9 8.5 30.6 13.2 92.0 7.4 21.5 9.2
2006 104.5 10.5 42.3 18.6 115.3 10.0 31.5 13.8
2007 97.0 9.5 83.1 39.6 106.0 10.1 74.1 34.6
2008 7.4 0.5 2.4 1.1 8.0 0.5 1.9 0.8
Total 396.7 37.0 178.7 81.4 435.1 34.1 140.9 63.9
Figures 20 and 21 present the same information as Figures 18 and 19, except here, term
defaults and losses are turned back on again. The loans that term default are not reflected in
the figures. Rather, the figures represent the situation at maturity for those loans that survive
to maturity. Of course, the term defaults will themselves represent additional opportunities,
particularly for distressed real estate and loan investors. These are not captured in the
figures.

Figure 20: Approximate Size and Equity Deficiency for Salvageable and Non-Salvageable Loans by Maturity Year:
With Term Defaults
LTV <=100 LTV > 100 LTV <=100 LTV > 100
Maturity Balance Deficiency Balance Deficiency Balance Deficiency Balance Deficiency
2009 14.2 0.7 1.5 0.7 14.4 0.6 1.3 0.6
2010 24.2 2.1 7.8 3.1 25.4 2.2 6.5 2.6
2011 28.2 2.5 12.4 5.8 30.5 2.4 9.3 4.3
2012 28.2 2.6 24.7 12.2 32.2 2.5 19.0 8.8
2013 28.8 2.3 6.3 2.6 32.9 1.8 3.3 1.4
2014 33.4 3.1 8.9 3.5 39.5 2.8 5.0 1.9
2015 67.7 6.3 9.6 3.6 74.9 5.2 7.0 2.6
2016 84.0 7.9 15.8 6.0 93.9 7.8 16.4 6.1
2017 74.7 6.8 21.2 8.0 82.8 7.4 25.5 9.8
2018 3.5 0.1 0.2 0.1 3.7 0.1 0.2 0.1
Total 386.8 34.5 108.4 45.4 430.2 32.7 93.7 38.1
Figure 21: Approximate Size and Equity Deficiency for Salvageable and Non-Salvageable Loans by Vintage: With
Term Defaults
LTV <=100 LTV > 100 LTV <=100 LTV > 100
Vintage Balance Deficiency Balance Deficiency Balance Deficiency Balance Deficiency
2000 9.2 0.3 0.5 0.2 9.2 0.3 0.4 0.2
2001 14.7 0.9 1.4 0.6 15.1 0.7 0.6 0.3
2002 15.4 1.1 1.7 0.7 16.2 0.7 0.7 0.3
2003 24.9 1.9 3.2 1.2 27.3 1.3 1.2 0.4
2004 38.5 3.3 6.3 2.4 43.1 2.6 3.5 1.3
2005 81.6 8.3 20.6 8.3 91.0 7.2 15.4 6.1
2006 99.7 9.5 24.4 9.9 112.7 9.6 21.4 8.5
2007 91.3 8.6 48.6 21.3 103.2 9.7 49.1 20.5
2008 6.5 0.3 1.6 0.8 7.3 0.4 1.4 0.6
Total 381.8 34.2 108.3 45.4 425.2 32.6 93.7 38.1
Figures 22-26 show different stratifications for maturity LTVs assuming there are no term
defaults. For each figure, the x-axis is maturity LTV. Figure 22 provides a histogram for
maturity LTVs by dollar amount. The very large upper tail of the distribution represents loans
with very high LTVs. Of course, most of the very high LTV loans term default prior to
maturity.

Figure 22: Distribution of Maturity Date LTVs Assuming No Term Defaults: Severe Stress Scenario
120
110
100
90
80
Amount ($ Billions)
70
60
50
40
30
20
10
0
<60 60-70 70-80 80-90 90-100 100-110 110-120 120-130 130-140 140-150 >150
Figures 23 and 24 stratify the maturity LTV data by origination vintage. The figures present
the cumulative distribution functions for vintages 2000, 2003, 2005, 2006, 2007 and 2008.
Each bar represents the percentage of loans with maturity LTV at, or below, the indicated
level. For example, 48% of the 2000 vintage have maturity LTVs below 60%, while only 13%
of the 2007 vintage have maturity LTVs of 60% or below.
It can be seen that seasoned vintages contain much higher proportions of loans with lower
maturity LTVs than more recent vintages.
Figure 23: Cumulative Distribution of Maturity LTVs by Origination Vintage: Severe Stress Scenario
2000 2003 2005 2006 2007 2008

100
90
80
70
Cumulative %
60
50
40
30
20
10
0
<60 60-70 70-80 80-90 90-100 100-110 110-120 120-130 130-140 140-150 >150

Figure 24: Cumulative Distribution of Maturity LTVs by Origination Vintage: Moderate Stress Scenario
2000 2003 2005 2006 2007 2008

100
90
80
70
Cumulative %
60
50
40
30
20
10
0
<60 60-70 70-80 80-90 90-100 100-110 110-120 120-130 130-140 140-150 >150
Finally, Figures 25 and 26 provide the same information as Figures 23 and 24, except the data
is stratified by property type. These two figures indicate clearly the degree to which loans on
office, multifamily and retail were over-leveraged relative to loans on industrial.
Figure 25: Cumulative Distribution of Maturity LTVs by Property Type: Severe Stress Scenario
Industrial Multifamily Office Retail

100
90
80
70
Cumulative %
60
50
40
30
20
10
0
<60 60-70 70-80 80-90 90-100 100-110 110-120 120-130 130-140 140-150 >150

Figure 26: Cumulative Distribution of Maturity LTVs by Property Type: Moderate Stress Scenario
Industrial Multifamily Office Retail

100
90
80
70
Cumulative %
60
50
40
30
20
10
0
<60 60-70 70-80 80-90 90-100 100-110 110-120 120-130 130-140 140-150 >150

V. A Look at Commercial Real Estate Problems in Bank Portfolios

It is difficult to conjecture about how the problems in CMBS may unfold without considering,
in some detail, the situation of commercial real estate loans in bank portfolios. In fact, we
believe that commercial real estate problems in banks are likely to have a dominant impact on
CMBS, and the rest of the commercial real estate debt markets as well. There are several
reasons for this. First, commercial real estate exposure in bank portfolios is enormous, much
larger than the CMBS market. Second, we believe that commercial real estate loans in banks
are, on the whole, at least as risky, and possibly significantly riskier, than those in CMBS. And
third, extreme stress is likely to develop in bank commercial real estate loans well before it
does in CMBS loans.
In aggregate, banks have approximately a $1.7 trillion exposure to loans classified as

commercial real estate loans. This is comprised of about $1 trillion of “core” commercial real
estate loans, $532 billion of construction and land development loans and $150 billion of
multifamily loans. Moreover, their commercial real estate exposure represents more than
25% of total assets. Importantly, this exposure increases markedly for smaller banks. For the
four largest banks (on the basis of total assets), this exposure is 12.3%, for the 5-30 largest
banks, the exposure is 24.5%, while for the 31-100 largest banks, the exposure grows to
38.9%.
Below, exposures for both construction and core commercial real estate loans are presented
separately for four different size categories of banks (where size is based on total assets):
• Category 1: Banks 1-4
Category 1 represents the largest money center banks; category 2 represents the super
regional and large regional banks; category 3 contains average size regional banks having
total assets in excess of $25 billion; category 4 reflects smaller regional banks and larger
community banks with total assets of $10-$25 billion.
Figure 27 presents the exposures, since Q1 2003, of the four categories of banks to
construction and land development loans. The average exposure in recent years has been
about 1% for the four largest banks, but 8-9% for banks 51-97.
The story is similar for core commercial real estate loans. Figure 28 presents the data. The
exposure of the largest banks has averaged only about a 2% over time, while that of the 51-
97 largest banks has been in the 15% range.
One other interesting observation is that construction loan exposure appears to have been
declining over the past 18 months or so, while commercial real estate exposure has been
increasing. This is particularly noticeable for the 51-97 largest banks. We conjecture this
reflects construction loans on completed projects being transferred to the commercial real
estate category, perhaps via mini perm loans or other bridge financing. To the extent that this
is the case, the commercial real estate exposure could entail significantly greater risk.

Figure 27: Bank Exposure to Construction and Land Development Loans
Banks 1-4 Banks 5-19 Banks 20-50 Banks 51-97

10%
9%
Exposure To Construction Loans
8%
7%
6%
5%
4%
3%
2%
1%
0%
2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1
Source: Deutsche Bank and SNL Financial
Figure 28: Bank Exposure to Core Commercial Real Estate Loans

16%
14%
Exxposure To CRE Loans
12%
10%
8%
6%
4%
2%
0%
2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1
In terms of risk, construction and land development loans are, without doubt, the riskiest
commercial real estate loan product. The credit risk is so significant that they were never
deemed appropriate for CMBS and, in fact, there was very little incidence of them appearing.
Values for properties with vacancy issues are down by enormous magnitudes in today’s
environment, as recent sales of distressed office properties in Manhattan have made it
abundantly clear. Properties under construction, or newly completed properties, are the
poster children for properties with vacancy issues. Values here must be down by extremely
large percentages. As a result, loss severities on defaulted construction loans will be
extremely high, possibly as high as 75%, or more.

Construction loans in bank portfolio are already exhibiting surging delinquency rates. Figure
29 presents historical total delinquency rates (i.e. 30 +) for construction loans, again broken
out by bank category.
Figure 29: Total Delinquency Rates (30+ Day Delinquency) for Construction Loans in Bank Portfolios

18%
16%
14%
Total Delinquency Rate
12%
10%
8%
6%
4%
2%
0%
2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1
Total delinquency rates have reached 12% for the largest banks and 16% for regional banks.
While this is certainly an appalling number, we believe it vastly understates the true
magnitude of the problem. The reason is that construction loans are almost always structured
with large upfront interest reserves that are sufficient to pay the interest on the loan during
the construction period, typically two to three years. Moreover, as construction loans are
typically floating rate loans, and short-term interest rates have plummeted since 2007, the
cost of debt service has declined significantly. Therefore, the interest reserves in construction
loans may actually be sufficient to carry the loans for another 12-24 months. However,
eventually interest reserves, and time, will run out on these loans and at that point we expect
to see a massive wave of defaults.
In our view, ultimate losses on construction loans are likely to be at least 25%, and possibly
much more. This would imply losses of at least $130 billion on construction loans in bank
portfolios.
Turning to core commercial real estate loans in bank portfolios, our view is that this segment
is at least as risky as the fixed rate CMBS sector, and probably significantly more risky. Our
view is based on the following points:
1. First, the CMBS market grew dramatically over the past few years, from $93
billion in issuance in 2004, to $169 billion in 2005, to $207 billion in 2006 to
$230 billion in 2007. Much of the growth in market share came at the expense
of banks, as CMBS siphoned off many of the desirable loans on stabilized
properties with extremely competitive rates. Banks, funding themselves at L-
5bp simply couldn’t compete on price terms given the execution that was
available in CMBS at the time. This forced banks, particularly regional and
community banks, into riskier lines of commercial real estate lending, like condo
conversion loans.

2. Because of their liability structure, bank commercial lending has always tended
to focus more on shorter term lending on properties with some transitional
aspect to them—properties with a business plan. Such transitional properties
typically suffer more in a downturn as the projected cash flow growth fails to
materialize.
3. Because bank loans typically have three to five year terms, a very large
percentage were originated at the peak, 2005-2007, and will mature at the
trough of the downturn, 2011-2012. Most CMBS loans originated during the
2005-2007 period mature during 2015-2017.
4. The view that core commercial real estate loans in bank portfolios are at least as
risky as loans in the fixed rate CMBS sector gains support by the fact that
delinquency rates on the former have consistently been significantly higher than
those on CMBS loans. Figure 30 compares historical total delinquency rates for
the four categories of banks to that of CMBS. The total delinquency rate on
bank loans have typically been two to three times higher than that on CMBS.
Figure 30: Total Delinquency Rates: Bank Commercial Real Estate Loans Vs. CMBS
Top 4 5-19 Over $25bn $10-$25bn CMBS

4.0%
3.5%
Total Delinquency Rate
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
2006Q1 2007Q1 2008Q1 2009Q1
Because of the reasons outlined above, we believe it is reasonable to expect that total losses
on bank core commercial real estate loans will be at least as large as those on CMBS loans
originated during the same period. From Figures 9 and 10, this suggests losses in the ranges
of 11.6% - 15.3%, or roughly $115 - $150 billion.
Thus, our estimate of losses for banks from the combination of construction and core
commercial loans alone is $250 - $300 billion. This excludes losses from multifamily loans,
which, admittedly, should be much lower given the size of the exposure.
Finally, looking at the net charge offs that have already been taken by banks, the cumulative
(since Q1 2008) net charge offs for construction loans ranged from a high of 25% for
Category 3, to a low of 8.7% for Category 1. See Figure 31. It appears as though banks have
a long way to go in charging off reasonable amounts for construction loans.

However, the situation is far worse in core commercial real estate loans, where we expect to
see 11.6% - 15.3% total losses. Here, cumulative net charge offs since Q1 2008 range from
a high of 3.2% to a low of 0.3% (for the large money center banks).
Figure 31: Bank’s Net Charge Offs for Construction Loans
Top 4 5-19 Over $25bn $10-$25bn

12%
10%
8%
Net Charge Offs
6%
4%
2%
0%
-2%
2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1
Figure 32: Bank’s Net Charge Offs for Core Commercial Real Estate Loans
Top 4 5-19 Over $25bn $10-$25bn

1.2%
1.0%
0.8%
Net Charge Offs
0.6%
0.4%
0.2%
0.0%
-0.2%
2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1
For both construction and core commercial real estate loans, net charge offs to date have
been highly inadequate. This is clearly a problem that is being pushed out into the future.
In our view, banks will, once again, be at the epicenter of the commercial mortgage crash,
just as they were in the early 1990s. Within the banking sector, we believe that smaller
regional and community banks are likely to suffer disproportionately. The way in which
regulators respond to this crisis will be a key determinant of how long the commercial real
estate market remains mired in these problems. If banks are allowed bury problem loans
away in their portfolios for years via massive term extensions, this is likely to a very long
process. If, on the other hand, banks (and CMBS special servicers too, for that matter) are
required to deal with problems in a timely manner, the process, which will be unavoidably
painful, is likely to be much shorter duration.

V. Conclusions
Our updated analysis continues to suggest that the majority of CMBS loans that survive until
maturity will fail to qualify to refinance without major equity infusions. However, by
introducing term defaults into the picture in an internally consistent way, we conclude that a
significant proportion of loans of loans (15-20%) are expected to default prior to maturity.
Our estimates of total losses, at 9-12% for the outstanding CMBS universe as a whole, and
11.6-15.3% for the more recent vintages (2005-2008), suggest that the intensity of the
current commercial real estate crash may eventually exceed that of the early 1990s, possibly
by a significant degree.
Banks, in particular, look vulnerable, especially smaller regional and community banks that
have very high exposures to highly toxic construction and land development loans. We
expect that they will, once again, mark the epicenter of commercial real estate problems.

Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see
the most recently published company report or visit our global disclosure look-up page on our website at
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Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the
undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in
this report. Richard Parkus
Deutsche Bank debt rating key
Buy: These bonds are expected to outperform other

issues in the sector/industry group over the next three
to six-month period.
Hold: These bonds are fairly valued currently. If owned,
no need to sell, but we await events/ releases/
conditions that would make the bond attractive enough
for us to upgrade. In the interim, the bond will likely
perform as well as the average issue in the
sector/industry group.
Sell: There exists a significant likelihood that these
bonds will underperform relative to other issues in their
sector/industry group, at least over the next three
months.

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The Future Refinancing Crisis in Commercial Real Estate: CMBS Research

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North America United States

The Future Refinancing Crisis Richard Parkus

in Commercial Real Estate richard.parkus@db.com

Jing An, CFA

Part II: Extensions and Refinements

Deutsche Bank Securities Inc.

Page 2 Deutsche Bank Securities Inc.

• Total losses on the 2005-2008 vintages will be 11.6-15.3%

• Total losses on the 2007 vintage will exceed 21%

Deutsche Bank Securities Inc. Page 3

Page 4 Deutsche Bank Securities Inc.

II. Review of the Methodology and Previous Results

Figure 1: Degrees of Stress in the Two NOI Projection Scenarios

Average of Maximum NOI Declines Across MSAs

Property Type Severe Recession Scenario* Moderate Recession Scenario **

* PPR's "Severe Recesion Scenario" as of Q3 2008

Source: Deutsche Bank and Property and Portfolio Research

Deutsche Bank Securities Inc. Page 5

Figure 2: Assumed Cap Rates for Projections

* Hotel projection not based on PPR projections

Source: Deutsche Bank

• Minimum DSCR: 1.3x

Page 6 Deutsche Bank Securities Inc.

Source: Deutsche Bank and Intex

Deutsche Bank Securities Inc. Page 7

Non-Refinanceable Loans Maturity Default

* Excludes defeased loans

Source: Deutsche Bank

Page 8 Deutsche Bank Securities Inc.

* Excludes defeased loans

Source: Deutsche Bank

* Excludes defeased loans

Source: Deutsche Bank

Deutsche Bank Securities Inc. Page 9

Severe Stress Moderate Stress

Existing Losses Projected Losses Projected Losses

* Percentage of original balance

Source: Deutsche Bank

Page 10 Deutsche Bank Securities Inc.

III. Introduction of Term Defaults and Its Impact on the Results

Projected Term Projected Maturity Existing Projected Total

Source: Deutsche Bank

Deutsche Bank Securities Inc. Page 11

Projected Term Projected Maturity Existing Projected Total

Source: Deutsche Bank

Projected Term Projected Maturity Existing Projected Total

Origination Default Loss Default Loss Loss Default Loss

Source: Deutsche Bank

Page 12 Deutsche Bank Securities Inc.

Source: Deutsche Bank

Projected Term Projected Maturity Projected Total

Source: Deutsche Bank

Deutsche Bank Securities Inc. Page 13

Projected Term Projected Maturity Projected Total

Source: Deutsche Bank

Page 14 Deutsche Bank Securities Inc.

Figure 15: Projected Timing of Term and Maturity Defaults/Losses

Term Losses Maturity Losses Total Losses