credit risk in commercial real estate structured financing
DESCRIPTION
Credit Risk In Commercial Real Estate Structured FinancingTRANSCRIPT
DEBELLUT Vianney,
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I.A Typical scheme of a structured project financing
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SVP
Asset
Bank
Non recourse loan & pledge on the SPV’s shares
Debt service &
Delegation of the rents
Mortgage
Rental revenues
Holding100%
Investors(Corporate or funds)
30% of equity
70% of debt
1. Office2. Retail3. Hotel4. Warehouses
I.B Profitability analysis: RAROC
RAROC, measure of risk-adjusted profitability
(≠Return On Equity)
= Expected Revenue – Average loss projected
Economic Capital
Inputs:• Spread • Fees• Customer relationship, • Management costs • Risks
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Subordination
Profitability sensibility to ratings (PD) and LGD
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RARORC for a 5 y deal at 50 bp
-100%
-50%
0%
50%
100%
150%
200%
1 2+ 2 2- 3+ 3 3- 4+ 4 4- 5+ 5 5- 6+ 6 6- 7+ 7 7-
LGD = 45%
LGD = 25%
LGD = 10%
I.C Risk analysis: Rating PD Market risks :
Supply/demand Projections on rents and prices of the buildings Liquidity
Asset risks : Asset type Location Shape Rental situation: vacancy, quality and diversity of tenants ,
rents comparing to market rents Assets’ value
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Financing structure risks: Subordination (senior, junior, mezzanine) Leverage (LTV) Amortizing process (bullet, interest only, linear) and
maturity duration Last LTV ratio (refinancing risk)
Cash flows model: base case and stress case: Ratios (debt service coverage ratio, interest coverage ratio)
Specific risk: Country risk Counterparties risks (if obligor)
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Example of rating migration and default probability
Haircut on the collateral value in function of: Asset type Portfolio diversification Country Asset value volatility Asset liquidity
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I.C Risk analysis: LGD
I.D RAROC optimization Attractive location, liquid collateral and experimented asset manager
Loans with good credits and positive anticipations
Limited Loan To Value and significant amortization => short duration and low refinancing risks.
Stable revenues and increasing solvability ratios (Interest coverage ratio, debt service coverage ratio)
With distribution, the weight of the fees increase => Underwriting followed by distribution for the less profitable tranches and deals
To avoid concentrations and diversify with low correlations between countries, asset types and investment strategies.
Targeted clients and markets cross selling opportunities and high potential
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To diversify the loan portfolio
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=> Use retail (countercyclical) and hotel (cyclical) to lower risks
Within the USA the diversification is limited (high correlation) but it’s interested to invest worldwide
Tools for the loan portfolio management
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1 is the most important tool !!