USRT - CMBS Credit: View From The Ground Floor
2023-08-16 02:00:00 ET
Summary
- CMBS loan defaults are rising - what lies ahead for near-term loan performance?
- Commercial real estate has been an area of intense focus for investors, with concerns that macroeconomic uncertainty, tighter financial conditions and work-from-home could foreshadow deteriorating credit performance.
- The catalysts for CMBS distress include the inability to refinance maturing loans, higher interest rates pressuring borrowers with floating-rate financing, and business model challenges within the office and retail sectors.
By Jose A. Pluto, CFA
CMBS loan defaults are rising - what lies ahead for near-term loan performance?
Commercial real estate has been an area of intense focus for investors, with concerns that macroeconomic uncertainty, tighter financial conditions and work-from-home could foreshadow deteriorating credit performance.
The catalysts for CMBS distress include the inability to refinance maturing loans, higher interest rates pressuring borrowers with floating-rate financing, and business model challenges within the office and retail sectors.
Through June 2023, 30+ day conduit delinquency rates for this universe were 3.9%, while special servicing rates (an indicator of potential future distress) were at 5.6% - and these rates have risen over the past 12 months.
In conduit CMBS, delinquency rates have risen by 0.6% since the December 2022 lows. In SASB CMBS, delinquency rates have risen to 3.2%, led by high-profile office property defaults with special servicing rates rising commensurately to around 6.5%.
We expect delinquency and special servicing rates to continue rising over the next 18 months due to higher interest rates, tighter refinancing conditions and lower property valuations.
Challenges will be most acute for borrowers with near-term loan maturities, floating-rate debt and high leverage. At the current pace of defaults, we expect delinquencies to reach 4.5 to 5.0% by year-end and 7 to 8% by December 2024. The drivers for delinquency expectations include payoff rates for maturing loans and term defaults among office loans.
The dramatic increase in the cost of floating-rate funding should drive the delinquency outlook for single-asset, single-borrower (SASB) CMBS. According to Bloomberg data, approximately one-third of floating rate CMBS loans have debt yields that likely do not cover their current interest cost.
This is particularly evident in SASB office loans where, as highlighted by Deutsche Bank, serious delinquency rates for floating rate office loans are almost seven times higher (9%) than for fixed rate office loans (1.3%).
That said, over 60% of low-debt-yield loans are secured by industrial or multifamily properties - sectors with the strongest fundamental outlook.
While tighter credit conditions and higher rates create a more challenging environment for refinancing, total borrowing needs will likely be more modest than the much-ballyhooed $235 billion CMBS debt maturity wall in 2023 to 2024 might suggest.
Of the loans coming due, more than half (52%) are floating rate, with contractual extension options that permit borrowers to extend the loan maturity for up to five years.
For borrowers that do not have extension options, maturity defaults will likely be addressed through modifications that extend the loan term.
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CMBS Credit: View From The Ground Floor