Trepp: Near-term CRE maturities may be driving 'strategic' defaults

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Some commercial real estate borrowers with near-term maturities appear to be strategically defaulting on their loans held in bank portfolios, a trend that could bring about a “wave” of foreclosures in the next four to six quarters, according to a report from Trepp.

In a September update on bank CRE holdings, Trepp stated that delinquency rates for CRE and commercial & industrial loan holdings at banks is 1.66% for those maturing in the next five quarters is 1.66%, or six times the rate (0.27%) of the remaining loan portfolio maturing after the third quarter of 2021.

“Loans with maturity dates in the next five quarters have delinquency rates materially higher than the overall portfolio,” according to Trepp’s report.

Delinquencies for loans maturing through the third quarter of 2021 represent 47% of the overall delinquent balance of the loans tracked in Trepp’s anonymized bank-loan data repository, which accounts for about $146 billion in outstanding CRE loan and $33 billion in C&I obligations.

During the second quarter, the overall delinquency rate for bank-held CRE loans increased to 0.59% from 0.36%, the highest level during of the post-crisis recovery period, but well below the peak 9% CRE delinquency rate in the midst of the 2008-2009 recession.

(While delinquencies on securitized commercial loans has been on the decline since the peak of the COVID-19 economic crisis, troubling signs are also afoot for MBS investors: a growing number of loans classified as newly delinquent last month, and a larger number of mortgages being sent to a special servicer being at-or-near default.)

But now with COVID-19-related stresses affecting CRE and commercial and industrial loan performance, Trepp says there are signals that many CRE borrowers — particularly large-loan obligors in the hotel and retail sectors — to make a “rational decision” to strategically default, since they face bleak prospects for extensions or refinancings when loans come due through next year, Trepp concluded.

“The elevated delinquency rate for loans nearing maturity is most likely driven by borrowers strategically stopping payments in advance of their maturity date in the expectation that they will not be able to extend or refinance their loans at maturity,” the report stated.

The loans with nearer-term maturities show no difference in composition and risk profile to other loans in the pool, Trepp added.

Approximately $4.3 billion in CRE loan balances maturing in the third quarter have a delinquency rate of 2.32%, including 1.31% that are between 90 and 179 days past due (compared to nearly none of the more than $10.6 billion in bank-held CRE loans maturing between the fourth quarter of 2020 and the second quarter of 2021).

This suggests “that these borrowers are much less likely to recover. This could potentially lead to a wave of foreclosures in the coming quarters, especially in jurisdictions where foreclosure moratoriums have been in place but have expired or will expire soon.”

Further exacerbating the risk is the fact that large-balance loans have a disproportionate share of the delinquency balance for loans maturing in the next five quarters: loans over $25 million represent 36% of the total outstanding balance but 57% of the delinquency balance. “Larger borrowers are typically more sophisticated and less likely to be encumbered by recourse or guarantees,” leading to the strategic default stage for some borrowers, the report added.

Smaller loans under $1 million still have higher delinquency rates at 1.24% are double that of other loans, which “supports the narrative that smaller businesses are being more directly impacted by the pandemic related economic shutdown,” noted Trepp’s report.

In individual sectors, retail and hotel properties have the highest delinquency rates at 1.65% and 0.74%. Industrial properties are “far outperforming” the overall CRE portfolio with only a 0.17% delinquency rate.

Multifamily loans, while performing “slightly better” than other loans with a 0.38% delinquency rate, have a much higher share of its overall delinquencies (68%), according to the report, “which are either seriously delinquent or in non-accrual which means that these loans are more likely to reach foreclosure and could do so more quickly than other property types.”

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