CMBS borrowers face $52bn near-term refinancing hurdle for loans with low DSCRs 

While borrowers are already feeling the impact of higher interest rates, the low DSCRs will present a particular problem as refinancing looms. 

The commercial mortgage-backed securities market is facing a $52 billion wall of near-term maturities of loans with debt service coverage ratios of 1.25 or less in the next 24 months, according a report released this month from New York-based data and analytics provider Trepp. 

While borrowers are already feeling the impact of higher interest rates, the low DSCRs will present a particular problem as refinancing looms. 

“There are approximately $52 billion of commercial real estate loans maturing over the next year and the problem is a lot of them have debt service coverage ratios below 1.25,” Emanuel Grillo, partner at global law firm Allen & Overy, told Real Estate Capital USA. 

DSCR, a metric that evaluates a sponsor’s ability to repay debt calculated by dividing a property’s net operating income by its debt service, plays a significant role in the assessment of refinancing maturing loans. 

“This means [the loan’s] close to the bone as it is, and if they have got to go and refinance at interest rates that are materially higher than their last debt instruments were, they’re going to have a difficult time doing that. We are looking at a potential nightmare scenario,” Grillo said. 

According to the Trepp database, the aforementioned $52 billion worth of maturing loans are comprised of just over 3,000 properties. Almost half of the properties are multifamily with roughly 1,450 properties meeting the above criteria. Additionally, $17 billion of the $52 billion has occupancy below 80%.

“Some see this as a leading indicator of broader distress finally playing out in the marketplace, while others would argue this volume of loans barely scratches the surface,” the paper reads.

Taking a broader view, Trepp research also found there is a total of roughly $97 billion of conduit loans set to reach maturity within the next 36 months. Removing delinquent loans, loans with DSCR levels of 1.0 or less, and loans for which only partial 2021 financial data are available leaves nearly $60 billion of performing loans, most of which originated after the Global Financial Crisis. 

Trepp determined the ability of those loans to be refinanced by recalculating all loans to assume they required only interest payments, putting them all on equal footing. That resulted in a weighted average DSCR for the universe maturing within the next 36 months of 2.78.

Further recalculations showed the annual interest requirement for each loan, assuming it would refinance into a 6 percent loan. That reduced the weighted average DSCR to 2.4. 

Findings showed that almost 4.6 percent of the loans would have DSCR levels of less than 1.2. 

Furthermore, properties generating enough NOI to comfortably cover their current interest payments could fail a 1.2x coverage test in a refinancing, due to higher rates. Borrowers in those cases may not be able to take out a loan big enough to pay off an existing loan, requiring them to raise additional, higher-cost equity or mezzanine debt. 

According to Moody’s analytics, persistent restrained lending conditions should lead to an uptick in performing matured CMBS loans. 

Commercial property owners have had an amazingly strong tailwind, with interest rates declining sharply over 20 years and moving to near-record low levels during the coronavirus pandemic. During that time, owners had the ability to increase the leverage on their properties. 

“For example, a property that generated $1 million of annual net operating income would cover by 1.82 times the interest-only payments on a $10 million loan that had a 5.5 percent coupon,” reads a Moody Analytics report.If that loan was to have been refinanced 12 months ago, the property owner might have gotten a coupon of 3.5 percent. Assuming similar proceeds, the loan’s debt-service coverage ratio would jump to 2.86x. And to maintain a coverage level near the previous loan’s level, the property owner would qualify for a $15.5 million loan.”  

That, in part, explained the strong growth in property values in recent years. 

But during May and June, higher rates and reduced liquidity translated into a 52 basis point increase in CMBS performing maturities to 1.29 percent. However, precise figures are difficult to track, with many covid-19 affected loans benefiting from proactive servicing, which provided early maturity modifications, giving borrowers more time to refinance, the report stated. 

Green shoots 

Market participants should be optimistic when looking ahead, according to Grillo. 

“On the flip side [of the refinancing concerns], you’ve got some green shoots, with some big leases now starting to get signed and people getting more comfortable with what the new normal is going to be,” he said.  

He continued: “I also think there will be some increased deal activity and more money coming into it because the market is now finally getting into a sort of Covid reset,” he said.

“People are getting a sense of what the market is going to look like, how much space they are going to need, and then they are willing to sign up new deals in the newer higher-end properties. So there is movement at the top end of the market, whether or not that’s enough for the rest of the market still remains to be seen.”