Special Servicers Sort Out Billions in Delinquent CMBS
Data indicate the current volatility in commercial real estate prices and loan traffic in and out of delinquency will continue to keep billions in securitized CRE loans under the auspices of special servicers.
The Barclays Capital commercial mortgage-backed security credit report for October showed the roll rate from delinquent to current, or the percentage of securitized delinquent CRE loans that cured over a given month, fell to1.2% reversing September gains when the rate was 3.2%. It illustrates the contention that CMBS performance tends to be volatile when observed on a monthly basis, analysts wrote, “and often as long as a three- to four-month period is required to register formation of a truly new trend.”
Barclays also reported a 10 basis point increase in conduits 60 days or more delinquent to 9.1% by the end of October “mostly driven by the 2006 vintage” and 10-year loans unable to refinance from the 2001 vintage that now represent 48.5% of delinquent loans—even though at $4.1 billion these loans’ balances outstanding are relatively small. As financing becomes “less readily available especially in the secondary and tertiary markets” analysts expect to see more maturing loans “have trouble with refinancing and move into default” and into special servicing.
As of now Barclays said month-over-month the conduit concentration of loans in special servicing remained flat in October at 12.9% despite the fact that the 2006 vintage “underperformed with an increase of 30 bps” month-over-month and due to defaults on the same loans that helped increase the 60-days-plus delinquency rate.
Other insiders are equally pessimistic. There is “a formidable backlog” of loans in the pipelines in need of a resolution, says Stephanie Petosa, operational risk managing director at Fitch Ratings.
A Fitch special report entitled “Credit Crisis After Four Years” finds the balance of loans in special servicing as of June 30, 2011 (the transfer date) at $85.6 billion. The rating agency reported that since 2007 special servicers of securitized commercial mortgage loans have successfully resolved over $82 billion in distressed CMBS at an average recovery rate of 86%.
Fitch defines as resolved formerly delinquent loans that were liquidated, or paid off in some form and are now no longer in the trust, plus loans transferred out of special servicing because they returned to performing status. Based on the characteristics of the borrower as well as the property special servicers chose the workout strategy alternative that brings the most beneficial outcome for the trust.
Findings show that modification is “the most common resolution strategy” especially for the larger balance loans. At $28.6 million, the average size of a modified loan is almost three times larger than the size a liquidated loan, which is $9.6 million. However, Petosa told this publication, “It is too early to determine” what effect this high rate of modifications will have on final CMBS resolutions. “The impact and effectiveness of modifications on resolution rates is unclear.”
Fitch also found that smaller-size loans are mostly liquidated through sales, discounted payoffs or payments in full. Petosa did not offer any information about what types of investors are buying the small-balance loans at discount, cash prices, or property type and other investor preferences. “Not at this time,” she said.
Barclays reported similar findings noting that in October “liquidations were nearly flat” on a month-to-month basis at about $1.5 billion that include $840 million with high severity issues, compared to about $1 billion in September. What “continued to creep higher in October,” analysts wrote, was the number of loans liquidated with a loss severity greater than 3%. Also during the month the concentration of modified loans “remained nearly unchanged” at about 5.4% of all resolutions “as there were only a handful of new significant modifications reported.”
Other reports show instability in CRE prices and overall market performance. The October CoStar Group analysis of commercial real estate shows that by August four consecutive months of gains in CRE prices leveled off.
CoStar’s August 2011 National Composite Commercial Repeat Sales Index declined 0.5% compared to July, 3.6% from the same period last year, and 34.3% from its peak in August 2007. The report notes the decline was driven “mainly by softening pricing of high-end commercial properties, the segment most sensitive to the recent global financial market upheaval.” (CoStar’s August Commercial Repeat Sale Indices evaluated CRE pricing on 839 repeat sale transactions in August 2011 and over 100,000 repeat-sale transactions since 1998.)
The Investment Grade index also declined 2.7% in August, reversing a 1% gain in July 2011. It was, however, at 1.4% above the same period last year and 35.6% below its peak in August 2007. The change was accompanied by a slight decline in both distressed and nondistressed transactions reflecting “recent capital markets volatility and reduced CMBS lending.”
Only the General Grade index showed a 0.1% price gain continuing the upward trend of the previous four months thanks to higher sales of nondistressed properties while distressed sales as a percentage of total sales. It continued to decline gradually from their peak of 35.4% in March 2011 and accounted for 26% (216 sale pairs) of all repeat sale transactions in August 2011.
Even though distressed sales gradually declined over the past six months, the overall level was still historically high, suggesting that distress continues to be a dominant factor of CRE pricing. Nonetheless overall distressed sales as a percentage of total sales declined gradually in the last six months, which is part of the reason why this index remains 4.6% lower than August 2010 and 34.2% less than its peak in August 2007.
Overall, according to the CoStar Group findings CRE market fundamentals remain stable. (CCRSI, the CoStar Commercial Repeat-Sale Indices include 28 sub-indices—that include breakdowns by property type, region, transaction size and quality, and the top 10 metropolitan markets in the country—are reported on a monthly and quarterly basis.)
Third-quarter 2011 analysis finds that occupancy continued to improve across all commercial property types “although as yet without broad-based rent growth” resulting in stability that helped mitigate the impact of economic uncertainty.
CoStar reported a decline in the investment-grade transactions, where the volume fell by 10% from its six-month average, while the general-grade transaction volume stayed at par with its six-month average, with the average transaction size stable, at around $1.7 million. Total transaction dollar volume went down, however, by 8% from its six-month average.