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September 2 2010Please see the last page of this publication for important disclosures.

Brian Lancaster

MBS, CMBS & ABS Strategy

+1 203 897 6078

[email protected]

Richard Hill

MBS, CMBS & ABS St

+1 203 897 4679

[email protected]

Joseph Ruszkowski

MBS, CMBS & ABS Strategy

+1 203 897 4653

[email protected]

www.rbsm.com/strategy

rategy

de Value in

Environmentigh yielding

alternatives for some time now. While CMBS is obviously more

MBS currently offers

55 basis points of pickup in spread versus corporate bonds (Figure 1).

| S p e c i a l R e p o r t

2007 Vintage AMs Provi

a Compressing Yield Super senior CMBS have benefited from a lack of h

complicated to analyze than corporate bonds, C

Figure 1: Historical 10 Year AAA CMBS vs. 7-10 Year Corporates

0

200

400

600

800

1,000

1,200

1,400

1,600

A u g -

C M B S S t r a

t e g y

0 6 - 0 6

b - 0 7

a y - 0 7 0 7 - 0 7

b - 0 8

a y - 0 8 0 8 - 0 8

b - 0 9

N o v

F e M A u g -

N o v

F e M A u g -

N o v

F e M a y - 0 9

A u g - 0 9

N o v - 0 9

F e b - 1 0

M a y - 1 0

A u g - 1 0

S p r e a d t o L i b o r / S w a

p s

10 yr AAA CMBS Spread AAA/AA 7-10 Year US Broad IG Bond Index

BBB 7-10 Year US Broad IG Bond Index

Source: RBS, The Yield Book

Figure 2: 10 Year AAA CMBS vs. 7-10 Year Corporates (Since2008)

0

50

100

150

200

S p r e a d

250

300

350

400

450

Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10

t o

L i b o r

10 yr AAA CMBS Spread AAA/AA 7-10 Year US Broad IG Bond Index

BBB 7-10 Year US Broad IG Bond Index


While we believe CMBS is still attractive versus corporates, yields have

fallen significantly as have those on nearly all fixed income investments



The Royal Bank of Scotland

C M B S S t

t

| S

i l R

t | S

t

b

2 2 0 1 0

2

int traded inside of S+ 290

basis points resulting in an historically low yield of less than 5%.

Figure 3: Historical GG10 Spread / Price / Yields

For example, in August, GG10 A4s at one po

0

200

400

600

800

1,000

1,200

1,4001,600

1,800

2,000

J u

O c t -

J a n -

A p r -

J u l

O c t -

J a n -

A p r -

J u l

O c t - l -

0 7

0 7

0 8

0 8

- 0 8

0 8

-

J a n - 1 0

A p r - 1 0

J u l - 1 0

Y i e l d

( B p s )

40

50

60

70

80

90

100

110

D o l l a r P x ( $ )

0 9

0 9

0 9

0 9

Implied Swap Rate (Bps) GG10 Spread to Swaps (Bps) GG10 $ Price


As a result, investors have recently stepped up

moving down to the next safest part of the CMBS

AM class. This is reinforced by a sense that comm

fundamentals appear to be stabilizing.

their search for yield by

capital structure - the

ercial real estate

e focusing on the AM

art because they have

es. Conversely, many

bonds of more recent

vintages, such as 2007, as they are perceived as an asset class to

tors, such as life

6 vintage AMs has

se bonds now price

ss rather than dollar

s for 2005 and first

ss of BSCMS 2006-

+ 450 bps (6.11%

dollar price of nearly par. A month ago this same

bond traded at a price in the low $90s, a rise of nearly 10 points. In

contrast, 2007 vintage AMs have risen in price only several points. For instance, MSC 2007-IQ15 traded at $85 on August 2, 2010 and now

trades only 3 points higher at $88 as of September 1, 2010

While we don’t disagree with the move in earlier vintage AMs, we think

investors looking for yield at this point, with a little homework, can find

better relative value in the AMs off of many higher quality second half

2006 and 2007 vintage deals. Our analysis shows a number of these

bonds will not experience losses.

Within the AM class, real money investors ar

bonds of 2005 and first half 2006 vintages in p

approval to purchase many deals of these vintag

typically don’t have approval to purchase the AM

carry higher credit risk.

Indeed stepped up buying by real money inves

insurance companies) of 2005 and first half 200

increased to such a point in recent weeks that the

(as of last week) on a spread basis to the A4 cla

price.

This activity has significantly boosted dollar price

half 2006 vintage AMs. For example, the AM cla

PW12 (issued on June 21, 2006) now trades at S

yield) resulting in a




C M B S S t

t

| S

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t | S

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2 2 0 1 0

3

s currently trading

sulting in a base case

xpectations of 8.60%

($176 million), (for the analysis please see appendix A), the AM class

to over $452 million1

(22.26%) on MSC 2007-1Q15 before the loss adjusted yield of the AMh we have observed

).

s being

ould have

intages, not less. This is

later second half 2006 and 2007 vintage bonds have longer

wer dollar

longer maturities. This

ese later vintage

wngrades by the

rating agencies which could reduce liquidity. However, we would note

ve already been downgraded

with only a handful on watch for further downgrade.

s that we believe

Analysis

s of MSC 2007-IQ15

and calculated base cumulative loss expectations of 8.60% ($176

oans totaling over $27

everity of 41% ($176

are balloon maturity

d average loss

rticular concern:

and Wellington. We

ns in Appendix A.

Metroplex: The property is 211,734 square foot mixed use (retail /

office) development in San Diego, CA built in 1991. In February 2010,

minent payment

ng receipt of a borrower hardship letter. The property has

experienced a significant decrease in revenue and occupancy (tenantconcentration of furniture galleries and design related stores) due to

the economic downturn. We have performed a comp sales analysis of

the property and believe a loss severity of 77.5% or $31.17 million is

reasonable.

For example, the AM class off of MSC 2007-IQ15 i

(as of September 1, 2010) at $88 (S + 626bps) re

yield of 8.38%. Given our base cumulative loss e

does not experience a loss.

In fact, cumulative losses would have to increase

class falls below 6% (the base case yield at whic

that many 2005 and first half 2006 vintage AMs are trading

Additionally, after adjusting for credit quality and all other thing

equal, in a falling rate environment these bonds sh

appreciated a bit more in price than earlier v

because

durations than earlier vintage AMs both because of their lo

prices (resulting in a higher PO component) and

reinforces our view that value can be found in th

higher quality AMs

One concern some investors may have is potential do

that most AMs regardless of vintage ha

Please call us to further discuss additional bond

provide value.

Appendix A: MSC 2007-IQ15 Loan

We have performed a “bottoms-up” loss analysi

million). Our loss expectation is based on 26 l

million defaulting with a weighted average loss s

million). Of these 26 loans, 9 (totaling $142 million)

defaults due to inability to refinance (at a weighte

severity of 16.4%). The following loans are of pa

Metroplex, Jackson Portfolio, Steadfast Heritage

have provided further analysis of each of these loa

the loan transferred to the special servicer for im

default followi

1

Based upon a 6.75 CDR, 50% severity and 18-month recovery lag on loans that are not otherwisedefaulted in our loss model.




C M B S S t

t

| S

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t | S

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2 2 0 1 0

4

s of five apartment

een 1979 and 2001.

of Memphis). The loan

praisal valued the

t $36.2 million. Based upon a 10% haircut to this valuation

and less closing costs, we believe a loss severity of 54.64% or $35.5

square foot anchored

f Portland). The

In October 2009, the

y. The borrower

n into the property and is

bsurface Investigation

Report was ordered which found no significant impacts to the site. The

re. Discounting the

nd less closing

7 million is reasonable.

mixed use (retail /ach MSA) built in 2006

The loan was transferred

he special servicer in August 2009 for delinquency, counsel filed

foreclosure action and a receiver was appointment. Pursuit of the

borrower is also being analyzed due to misappropriation of funds after

appointment of the receiver. A January 2010 appraisal valued the

property at $17.3 million. Discounting this appraisal by 10% and less

closing costs, we believe a loss severity of 52% or $15 million is

reasonable.

Jackson Portfolio Roll-Up: The portfolio consist

complexes (total of 903 units) that were built betw

The properties are in Jackson, TN (88 miles NE

went REO in September 2009. A March 2010 ap

property a

million is reasonable.

Steadfast Heritage: The property is a 288,853

retail property in Albany, Oregon (70 miles south o

property was built in 1988 and renovated in 2006.

loan transferred to special servicing for delinquenc

indicated it has invested $5 million to $6 millio

not willing to invest more. A Phase II – Limited Su

special servicer is now proceeding with foreclosu

December 2009 appraisal of $19 million by 10% a

costs, we believe a loss severity of 58% or $21.

Wellington: The property is a 96,711 square footoffice) property in Wellington, FL (West Palm, Be

/ 2007. The property was built in 2006/2007.

to t




C M B S S t

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| S

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2 2 0 1 0

5

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