Record spike in delinquencies signals trouble in the US CMBS market

Ratings agency S&P expects the delinquency rate to climb higher for June, although European CMBS are so far weathering the storm.

The delinquency rate for US commercial mortgage-backed securities hit a record high in May and could spike to almost 10 percent in June, according to analysis from S&P Global.

The rating agency reported on 8 June that the US CMBS delinquency rate had jumped by an unprecedented 452 basis points between April and May to 6.17 percent. The percentage of loans classified as being in grace periods remained high at 7.15 percent in May – a drop from 7.62 percent in April, but which S&P said indicates “more trouble with CMBS loans”.

S&P also found the proportion of the outstanding CMBS loans balance that had been in grace periods in April and that went into delinquency in May to be more than 50 percent.

“Historically, the high grace loans have not impacted CMBS adversely as the grace-to-delinquent conversion ratio was around 2-3 percent,” S&P credit analyst Ambika Garg told Real Estate Capital. “However, last month we observed more than 50 percent [of] loans in grace became delinquent.”

Garg predicted that June’s delinquency rate could jump even higher if the grace-to-delinquent conversion ratio remains high.

“Under a similar scenario, where the grace rate for May 2020 remained elevated at 7.15 percent, a possible 50 percent conversion rate from grace-to-delinquent could yield a delinquency rate of just under 10 percent for June 2020,” said Garg.

On the plus side, she added, the reopening of the US economy could be a “positive sign” for loans categorised as in grace periods or loans that have recently become delinquent due to a temporary disruption in the market.

 Unprecedented yet expected

“The rate jump of 452 basis points to 6.17 percent in the US is unprecedented,” said Garg. “We have not observed an increase of this magnitude historically since we started tracking the delinquency rate [in January 2017].”

She added that although the equivalent rates for both 2011 and 2012 surged to more than 9 percent, these involved gradual and steady month-on-month increments.

Brian Stoffers, global president of debt and structured finance for capital markets at consultancy CBRE, said that last month’s uptick in US CMBS delinquencies was “sudden” but “expected”.

“These portfolios had substantial concentrations in retail and lodging, both affected by covid-19,” Stoffers told Real Estate Capital. “Unlike the post-GFC era, where delinquencies were largely attributed to aggressive lending and underwriting, most investors realise that issues being faced today are due to the pandemic.”

The delinquency rate increased for all major property types. However, lodging and retail demonstrated the highest magnitudes of increase at 17.5 percent for the former, up from 1.91 percent in April, and 9.26 percent for the latter, up from 2.78 percent. Garg expects these more susceptible property types, which depend on travel, leisure, and mobility, to retain elevated delinquency rates over the next few months.

Stoffers said: “While underwriting of retail and lodging going forward will be challenged and likely more conservative until a vaccine becomes widely available, CMBS will continue to play an important role in commercial and multifamily finance globally.”

In Europe’s far smaller CMBS market, S&P has not seen any new delinquencies in CMBS loans due to covid-19. However, Garg said this is due to loan sponsors injecting equity to prevent loan defaults, particularly in loans backed by shopping centres, hotels and student accommodation.

“The fact that they supported their loans indicates to us that they view their cashflow interruptions as temporary and not a permanent situation,” said Garg. “We noticed that even in those transactions that are backed by liquidity facilities and reserve accounts, sponsors chose to add equity instead of drawing on liquidity.”

She added that many of these loans have been written on a floating-rate basis and are benefiting from high interest coverage, given the current low rates. “Therefore, even if properties stabilise their cash flow to pre-covid levels, they may still be able to cover interest.”