CMBS Delinquencies Continue on Downward Track

The delinquency rate for commercial mortgage-backed securities (CMBS) continues to head lower, as borrowers refinance debt ahead of a wave of maturities in 2017.

The CMBS delinquency rate, which includes loans that are 30 days or more past due, fell to 5.42 percent in July, compared with 5.66 percent six months ago and 6.04 percent a year earlier, according to commercial real estate consulting firm Trepp LLC.

“What you’re seeing is a continuation of the trend where the markets are slowly healing, and new issuance activity is increasing the denominator and pulling the delinquency rate lower,” said Alan Todd, CMBS strategist at Bank of America Merrill Lynch.

Sean Barrie, a Trepp research analyst, noted that the longer the Federal Reserve takes before announcing an interest rate hike, “the more borrowers try to scramble and refinance loans.”

Trepp estimates that $300 billion in CMBS loans are scheduled to come due between 2015 and 2017.

“Given the liquidity in the market right now, we are expecting that most of those loans will pay off,” said Brook Sutherland, a senior director at Fitch Ratings.

Delinquency Rate by Property Type

The CMBS delinquency rate for the lodging sector dropped to 3.70 percent in July from 3.75 percent in June and 5.19 percent a year ago. Trepp noted that lodging remains the best performing major property type. Conversely, industrial delinquencies edged up to 7.41 percent in July from 7.12 percent in June. A year ago, however, industrial delinquencies stood at 7.89 percent.

While Trepp expects the delinquency rate to continue heading downward, the pace of improvement may soon slow. “Add a potential rate hike to the mix, and the delinquency rate may just bump along in the 5 percent range as more maturities send marginal loans to special servicing and default,” said Joe McBride, a research associate at Trepp.

Todd also sees the delinquency rate trending at a slow, steady pace. The next spikes, if any, are going to come in 2016 and 2017 when some of the loans from 2006 and 2007 hit maturity and borrowers may be unable to refinance, he explained.

Trepp is forecasting new CMBS issuance in 2015 to be 25 percent ahead of last year’s pace of $95 billion.

“Especially with all these loans maturing between now and 2017, the market really has to keep churning out new paper to digest them,” Barrie said.

Underwriting Slipping

While the CMBS market is showing clear signs of recovery, recent research conducted by Fitch Ratings points to potential issues with underwriting standards. Fitch’s study of CMBS transactions showed that credit enhancement levels declined even though collateral credit quality did not improve and in some cases declined.

Huxley Somerville, a managing director at Fitch and head of its U.S. CMBS group, said the decline in standards has been prompted in part by competition from new originators.

“What will be interesting to see is how does competition push underwriting further down for loans that are going to be made over the next six months,” Somerville said.

BAML’s Todd downplayed the underwriting worries. “We are seeing some signs that cash flows may be underwritten a little more aggressively, but quite honestly it doesn’t feel egregious,” he said.