Equity Losses Trigger More Vintage CMBS Defaults

Despite signs of a recovery and increased levels of real estate lending, devaluation is expected to lead to defaults at maturity for almost half of all securitized commercial loans monitored by Fitch Ratings.

The ratings agency finds that 41% of nearly 1,900 fixed-rate conduit CMBS loans rated by Fitch “would be unable to refinance under the agency’s defined stressed refinance parameters.”

The percentage increases to 59% when measured by loan balance.

These loans whose value totals $24 billion are expected to mature within the next 12 months.

The expectation to see a new wave of delinquencies, however, may not have a ratings impact, at least not immediately, Fitch said, because “potential maturity defaults are currently accounted for in the agency’s surveillance reviews.”

Under Fitch Ratings’ fixed-rate CMBS surveillance methodology, a loan with a debt service coverage ratio (DSCR) below 1.25x would be considered unable to refinance and would default at maturity. This DSCR calculation assumes a refinance interest rate of 8% and a 30-year amortization schedule and is considered a “stressed DSCR”.

Many loans originated in 2007 “underwritten to pro-forma income” have faced significant declines in value and consequently will find difficulties in refinancing. Of all 2007 vintage loans that mature in the next 12 months, 80% by number and 83% by balance would be unable to refinance, Fitch said, up 27% and 23%, respectively, compared to the seasoned 10-year loans originated in 2002.

A pool of loans from the 2005 and 2006 vintages that mature in 2013 are also likely to face difficulty as 57% of loans originated in 2005 and 69% of loans originated in 2006 may fail to refinance under the stressed parameters.

By property type hotels have the highest potential for defaults at 60% by number and 78% by balance, compared to 50% and 64%, respectively, for office loans, 49% and 73% for multifamily loans, and 32% and 44% for retail loans.

Data indicate that even the better performing sectors face higher default risk.

For example, “due to risks of tenant lease rollovers, recent store closures and big box tenant exposures,” and the gap between current rents and loans underwritten at the peak of the market, analysts remain cautious of retail loan performance going forward.

Multifamily loans on the other hand, which are backed by properties located in troubled or overbuilt states such as Texas, Florida, Ohio, Michigan and Nevada, may default at maturity given still gloomy recovery expectations in these states.

Furthermore, and not surprisingly, analysts wrote, the failure rate for Fitch Ratings’ refinance test for office loans located in primary metropolitan statistical areas “is significantly lower than that for loans located in secondary or tertiary markets” and for similarly unoptimistic recovery expectations.

Fitch’s list of the largest loans that were unable to meet its refinance test include Maryland Multifamily Portfolio, a $340 million multifamily property loan; the Hilton Hotel Washington, D.C., a $215 million loan; and a $173 million Galileo NXL Retail Portfolio 3 loan.

Fitch Ratings’ surveillance methodology for the rating of CMBS conduit transactions shows the average coupon ranges from 5% to 6%, so the calculations are based on the assumption of a current refinance rate of 6% and a 30-year amortization schedule.