CMBS Loss Severity Declines May Not Last

A higher number of conduit loans that back U.S. commercial mortgage-backed securities are being liquidated, and at a lower average loss severity rate. But as special servicers try to manage vintage deals more losses are expected this year and the next.

The average loss for CMBS conduit loans liquidated during the first quarter was 40.5%, down from 41% in 4Q 2011, according to Moody’s Investors Service.

Excluding loans with losses of less than 2%, the historical weighted average loss severity was 52.2% in the first quarter, down from 52.6% the previous quarter.

The report found that from April 1, 2011 to March 15, 2012, a total of $14.7 billion of CMBS debt was liquidated, up $2.3 billion over the same period the previous year.

Other data indicate the pattern persists. A Barclays’ report on May remits shows CMBS liquidation severities stepped to 55%, up another three points from April levels.

An earlier Barclays’ report that examined reasons why CMBS severities are in an upswing mode found that “special servicers have been looking to push liquidations in worse performing geographies,” marking “a shift in composition” that caused overall increases in loss severities this year.

Furthermore, the performance continues to differ by property type.

During the first quarter loss severity increases were minimal for industrial and retail properties, while the loss severity of the three other major property types declined slightly from the previous quarter, said a Moody’s VP and senior credit officer, Keith Banhazl.

Loans backed by retail properties had the highest weighted average loss severity, at 45.2%, while loans backed by office properties had the lowest weighted average loss severity, at 35.8%.

In the first quarter the total cumulative loan loss severities in U.S. CMBS transactions across the 1998 through 2008 vintages from Jan. 1, 2000 through March 15, 2012 increased 18 bps to 1.86% in 1Q12, up from 1.68% in the previous quarter.

The three vintages that saw the highest loss severities—2008 at 54.4%, 2007 at 49.4% and 2006 at 47.6%—constitute 57% of the CMBS collateral and 72.6% of all delinquent loans.

Since the aggregate loss for the troubled 2005, 2006 and 2007 vintages remains below 2.5% and represent between 7.2% to 11.8% of the total balance at issuance, analysts wrote, “most of the losses” are yet to be realized.

Higher delinquency rates across the board, especially among vintage deals, may also translate into higher loss severities.

Barclays’ May CMBS credit report found that the 30-day or more delinquency rate in the CMBS conduit market climbed to 10.5%, up 30 bps compared to April, “continuing the trend of the past few months.”

Predictably, most of the increase came from the 2002 and 2007 vintages as a number of 10-year and 5-year term loans that were not refinanced before they hit their maturity date but were transferred to special servicing instead, analysts wrote. The 2007 vintage delinquency rates were up 140 bps from April, while over-30-day delinquency rates for the 2002 vintage were up nearly 2%.

The largest loan to turn over 30 days delinquent in May was the $470 million Two California Plaza (GSMS 2007-GG10). The $284 million GSA portfolio (JPMCC 2007-LDP11) and the $95 million 17 Battery Place South (WBCMT 2007-C32) are another two large maturing loans that are now in special servicing.

It is not a good sign, according to Barclays’ analyst Keerthi Raghavan, the over-60-day delinquency rate “which is typically more stable than” the 30-day delinquency rate, increased 20 bps in May reaching 9.7% “across property types, with the exception of multifamily loans.”

Following “a slow start to the year,” the May remittance saw over $1.5 billion in loans exit the pool “with some non-zero realized loss,” analysts wrote. At nearly $1 billion, the bulk of the liquidation activity consisted of disposals from the 2006-07 vintages. Barclays’ analysts expect liquidation volumes in the United States will remain elevated.

Other data indicate a similarly weak CMBS performance in European markets that may or may not affect the U.S. market going forward.

According to a Moody’s Investors Service special report, 79% of the loans securitized in Moody’s-rated CMBS that matured in 1Q 2012 were not repaid by their scheduled maturity date.

Entitled “European CMBS Loan Maturity Outcome Q1 2012,” the report finds the non-repayment of CMBS loans has more than doubled from their 35% level in 2009 reflecting “the current weak state of the lending market.”

“The main driver underpinning whether or not maturing loans are refinanced is the loan-to-value ratio,” says Oliver Moldenhauer, a Moody’s VP, senior analyst based in Germany and author of the report. “Up to a Moody’s LTV of 80%, approximately two-thirds of the loans were repaid and the rest extended. In the LTV bucket above 100% nearly all the loans defaulted at their scheduled maturity date.”

Analysts found that loan size appears to be the most relevant factor in determining repayment upon maturity, compared to country and property type, which “do not provide clear indicators” for the refinancing of the loans under review.

“Anecdotal evidence of maturing loans over the past two years,” however, indicates that institutional quality borrowers have a higher chance of obtaining refinancing, especially for large loan sizes, Moody’s said.

Analysts expect the peak in refinancing needs will occur in 2012-2013. They caution that at least in European markets, “as banks need to deleverage due to regulatory requirements,” commercial real estate financing will remain constrained and most loans will not be repaid.