The commercial mortgage-backed securities (CMBS) market has gone full-cycle in a short time, from active in the first quarter of 2020 to effectively shut down in April/May, to now back open for business in 2021.
A confluence of factors related to the COVID-19 pandemic caused the interruption, including a rapid spike in CMBS delinquencies, forbearance requests, loans transferred to special servicing and others. According to MBA’s February 2021 CREF Loan Performance Survey, the balance of non-current commercial and multifamily mortgages decreased in February to its lowest level since April 2020. In that month, 94.8% of outstanding loan balances were current, up from 94.3% in January. Loans backed by lodging and retail properties continue to see the greatest stress. Because of the concentration of hotel and retail loans, CMBS loan delinquency rates are substantially higher than other capital sources.
The Trepp CMBS Delinquency Rate in March 2021 was 6.58%, a drop of 22 basis points from the February number. That marked the ninth straight month of decline. The peak delinquencies reported in mid-2020 and the fear they caused, along with a rapid and dramatic blowout in corporate bond spreads, gave CMBS lenders and the broader capital markets a reduced appetite for new commercial real estate-backed loans for a period. Now, with CMBS delinquencies trending down and a potential recovery in sight, substantial liquidity has returned to the market. For deals in demand and with the right shopping tips in mind, one would be hard-pressed to find a better time to be a borrower.
Whether looking for permanent or short-term financing, shopping around in a competitive and low-rate environment like today can help secure the best deal.
The CMBS narrative over the past six months can be summed up by two words: spread compression. According to the Commercial Mortgage Alert, spreads in February for AAA CMBS bonds were at 58 basis points, down from the April 2020 peak of 350 basis points. That has translated into real loan spreads on commercial assets in the standard 50%-59% loan-to-value (LTV) range as low as the 160-190 basis points over SWAPs for interest rates just under 3%.
The recent run-up in U.S. Treasury yields has seen real coupons rise as well, though not basis point for basis point due to spread compression. Higher leverage continues to be possible, though higher debt yield (debt yield is underwritten cash flow divided by loan amount) and debt service coverage ratio requirements are preventing LTVs from stretching too high.
For deals that fit a particular pool’s credit needs, CMBS originators are competing heavily for business, often down to the last basis point, and they are doing what they can to reduce or eliminate problematic CMBS structure issues to remain competitive, namely strict lockbox trigger language, downgrade language on credit tenancy or restrictive reserves. Lockbox triggers restrict a borrower’s ability to access certain revenues unless certain conditions are met, while downgrade language on tenancy matters relate to ratings migration when a tenant’s credit profile shifts negatively.
Still, it is not all good news. Uncertainty and questions are on investor’s minds for some asset types. For example, Fitch Ratings, a go-to agency for CMBS and CLO bond credit ratings, issued revised property cash flow and other underwriting assumption criteria when the MBS market reopened in May 2020. Those more restrictive underwriting assumptions affect retail and office assets, which are more likely to be affected by temporary collection issues with tenants or, in the case of hospitality, interruptions in revenue per available room (RevPAR) due to the COVID-19 pandemic. According to their report, Fitch will continue using these revised guidelines to evaluate underwriting on a loan-by-loan basis until it “sees meaningful signs of economic recovery and the negative impact on property performance subsides.”
To maintain as much transparency as possible, loan originators and credit underwriters are requiring highly detailed information on tenant relief, collections and common-area maintenance (CAM) reconciliation upfront. The reactions to more stringent criteria are translating into two net results: fewer deals overall are eligible for competitive pricing, so those that do qualify are able to compete for best-in-class terms; and there is currently less incentive for significant variation across originators, further commoditizing the CMBS space. But borrowers should expect that as the recovery continues, there could be more variation in underwriting and risk-based pricing and therefore opportunities to exploit market inefficiencies in the CMBS market over time.
Amid all the volatility in CMBS delinquency rates and forbearance agreements, less attention has been paid to the CRE collateralized loan obligation (CLO) market, which performed relatively well in 2020 from a credit perspective. A large share of the CRE CLO loan market outstanding is tied to multifamily collateral properties, which partially helps to explain this outcome. The delinquency rates for CRE CLOs came in just over 2% as of September 2020 compared to a CMBS delinquency rate of approximately 9% according to Moody’s Analytics.
CRE CLO pool loans to non-stabilized properties grew significantly for several years pre-COVID before screeching to a halt in the April-May 2020 period. According to Trepp, 2019 CRE CLO issuance grew to $22.4 billion, a 26% increase from the $17.7 billion issued in 2018. The 2018 issuance volume doubled the previous year in terms of dollar volume. Since the beginning of 2021, the market has seen a resurgence in appetite for new CLO issuance and a corresponding tightening of spreads.
There appears to have been a significant increase in bridge loan requests because of COVID-19 impacts. Bridge loans offered by banks, debt funds, mortgage REITs and some insurance companies typically have short durations (12-36 months) and are put in place to “bridge” specific issues that make traditional term financing more challenging. While many bridge lenders utilize warehouse lines (a line of credit that financial institutions provide to mortgage lenders), their balance sheet or investment funds, the CRE CLO market can be an attractive additional funding mechanism for some. As the CRE CLO market picks up steam again in 2021, look for this additional financing option to put downward pressure on the rates passed on to borrowers. All lender types have money, are bullish for 2021 and need to get money out the door even for non-stabilized properties.
It’s important to understand the fine print when getting a loan. Each lender and capital source works a little differently. Take the time to get educated on how different products may work in various scenarios including balance sheet vs. securitized products. Even within securitized products, a conduit loan, which is a commercial mortgage packaged with similar loans in a pool that is then sold to institutional investors, is very different than a bridge loan earmarked for a CRE CLO.
While the COVID-19 era has shined a light on the cracks in certain business models, the commercial mortgage space remains highly active, with deals that can survive slightly greater underwriting scrutiny receiving much greater competition and better terms at historically low rates. Borrowers who prepare themselves for a comprehensive presentation of the facts and for in-depth questioning can enjoy some of the best terms of an era, whether offered by a CMBS, insurance company, agency, bank or non-bank lender.
Andrew Foster is associate vice president of commercial real estate with the Mortgage Bankers Association. Cody Charfauros is a member of the structured finance team at Slatt Capital.