Troubled CMBS Loans Here to Stay

CMBS Loans, Trepp, 1st Service Solutions, Commercial Real Estate News, Finance News, Fannie Mae, Freddie Mac, Moody's Investor Service, Fitch Ratings

wall-street-23By Joe Gose

News that the commercial mortgage-backed securities delinquency rate increased six basis points to 6.1 percent in August after 14 months of declines indicate that troubled loans originated prior to the financial crisis are going nowhere fast.

[contextly_sidebar id=”HOIpPMBwk8bTrGrenXo6Qx3TreaLq0Q7″]According to CMBS researcher Trepp and other industry observers, not only did newly delinquent large loans on retail and industrial properties help push up the rate, but a low number of originations and a reduced amount of distressed asset liquidations in August compared with July also caused delinquencies to rise.

“These delinquency numbers have a lot of variables and aren’t something you can really bank on,” said Ann Hambly, founder and CEO of Grapevine, Texas-based 1st Service Solutions, an advocate for CMBS borrowers in loan restructurings and resolutions. “It’s not that the number of troubled loans are necessarily changing as much as what’s going on around them—loans coming in and those going out—that has been a diluting factor.”

The delinquency rate could remain at around 5 percent to 6 percent for the foreseeable future after dropping more than 400 basis points in a little more than a year, added Joe McBride, a research analyst with Trepp.

The uptick in the delinquency rate is coinciding with lower-than-expected CMBS originations so far in 2014 and reports of slipping underwriting standards, all of which highlight uncertainty about the market’s ability to regain its footing in the commercial property financing arena.

A healthy securitization market is considered critical to address some $330 billion in 10-year CMBS loans maturing through 2017. That’s about 14 percent of the roughly $2.3 trillion in outstanding commercial real estate debt in the United States.

Hambly is skeptical that the CMBS market will be able to handle the entire wave of maturities, however. More than 8,000 loans totaling $86.9 billion are maturing in 2015, for example, and at the end of 2013, 15 percent of those mortgages had estimated loan-to-value (LTV) ratios above 100 percent, or an outstanding balance that exceeded the property’s value, she said, citing Morningstar research.

Unless property values skyrocket in the near future—a scenario Hambly calls a “fairytale”—those borrowers won’t be able to refinance. Many properties are fully occupied with tenants paying market rate rents, she said, but they simply have too much debt.

Hence lenders and special servicers are likely to extend loans, just as they’ve been doing for troubled borrowers over the last several years, while counting on the Federal Reserve’s easy money policies to inflate values.

“The reason to extend the loan is that maybe property values will go up a little in two or three years and the loan losses will be a little less,” she said. “I think that’s about all you can hope for.”

Additionally, nearly 20 percent of the loans had LTVs of between 80 percent and 100 percent at the end of 2013. To varying degrees, those borrowers may need to find additional equity or mezzanine financing to qualify for a refinance, she added.

Even with the anticipation that $15 billion in new CMBS issuances will close in September—the most active month since 2007—originations for the year are likely to fall short of the projected $100 billion that industry observers foresaw early in 2014. Last year, originations totaled $80 billion, nearly double the amount in 2012. CMBS issuances totaled about $50 billion at the end of August, according to the Commercial Real East Finance Council.

With life insurance companies, banks, Fannie Mae and Freddie Mac, and other debt providers effectively competing with CMBS lenders, some observers suggest that CMBS lenders are loosening underwriting standards to win business.

Rating services Moody’s Investor Service, Fitch Ratings and Kroll Bond Rating Agency have highlighted trends of rising LTV ratios, the increasing use of interest-only payments for part or all of a loan’s term, and other weakening credit metrics over the last couple of years. Hambly also noted that she’s heard from borrowers who are unable to make payments on loans that mature in 2022 and 2023.

“We’ve already got a pipeline of troubled loans originated in 2012 and 2013,” she said. “And I see a lot of the same traits that we saw in 2006 and 2007, like interest-only terms or no reserves—the same old things.”

Regardless of the loosening standards, buyers of recent CMBS deals have bid down the yields that the bonds were initially expected to pay. That’s a sign that the investment appetite for commercial real estate debt remains strong.

“The demand for CMBS has always been there; it’s just that now there’s more supply,” McBride said. “This is an asset class that has a relatively higher yield than other assets with similar risk. So the search for yield goes on.”

West Coast Commercial Real Estate News