Delinquencies on commercial mortgage-backed securities loans, often seen as a proxy for the broader commercial real estate market, have been rising steadily as the Federal Reserve has increased interest rates over the past 18 months.
But there is a larger story behind the numbers, which has been influenced by what lenders, borrowers and servicers learned during the global financial crisis and, more recently, the covid-19 pandemic. Where there is a will to hang on to a property – and likely some fresh equity or gap financing – there might be a way to work out a troubled loan, market participants tell Real Estate Capital USA.
Stuart Rich, a senior managing director at advisory Black Bear Capital Partners, says the entire commercial real estate market continues to grapple with the impact of a federal funds rate that has risen by more than 500 basis points over the past 18 months.
“If you only bought properties in an appreciating market over the past 10 or 15 years, it is possible that you never had to deal with an issue with a loan,” Rich says. “If a sponsor comes to the table with a real business plan, the sponsor is likely to get an accommodation, or the servicer will find a way to work with them. If you bury your head in the sand, no one is going to work with you.”
A June report from New York-based rating agency KBRA found delinquencies for KBRA-rated deals dropped to 3.59 percent during that month. While this is a dip from the 3.82 percent rate seen in May, the agency tracked a handful of large delinquencies that were resolved, including a $782.8 billion loan on New York’s Seagram Building.
“If you bury your head in the sand, no one is going to work with you”
Black Bear Capital Partners
In its research, KBRA found that the drop in delinquency came from loans that are now categorized as current or performing matured rather than being disposed of from the pool.
At the same time, however, the agency found the number of loans being transferred to special servicing for an imminent payment or maturity default increased the total number of delinquent and specially serviced loans to 6.07 percent. This is a 12-basis point uptick from the same period a month prior.
“Interest rates are going up and loans are having a harder time getting refinanced, given where rates are and the liquidity in the market,” says Roy Chun, a senior managing director at KBRA.
Additionally, negotiations between borrowers and servicers take time. “The servicer is often looking for sponsors to put up additional equity or collateral, Chun says. “The servicer wants to make sure the sponsor is committed to the property before they make a decision to extend a loan.”
KBRA is expecting to see a continued increase in the delinquency rate, which Chun says will happen even if interest rates stabilize quickly. But the mitigant is that there is much more communication between borrowers and servicers as well as between master and special servicers.
“If you talk to servicers, they will tell you they learned a lot during the GFC. There is more communication, especially between the master and the special servicers, and that communication was shored up even more during the pandemic,” Chun says. “All the processes internally and between servicers were tested during the pandemic, which presented a much more compressed time frame for solving problems than what we are likely to face in the current environment.”
Christina Brodeur, managing director and head of CRE servicing and asset management at New York-based advisory SitusAMC, believes better technology and data is making it easier for servicers to identify potential problems early on.
“We are really working with sponsors to manage non-performing or troubled loans before they get to special servicing,” Brodeur says. “The industry is being more proactive around the data and resources that they have and we are identifying these loans well in advance of a transfer to special servicing.”
There is also a shift in the role that third-party servicers play, with Brodeur noting these firms are more seen as extensions of in-house asset management teams than third-party vendors.
“I think that what we saw during covid really highlighted the importance of data and analytics and really stepping beyond just looking at financials. It is more about understanding each of our respective lenders’ credit risks and appetite and helping to inform them and strategize before things go sideways,” she adds.
One of the ways the firm tries to get ahead of a potential problem is anticipating the impact of, for example, an interest rate hike.
“We can talk to our clients about what would happen if there was another 25bps interest rate hike. We can also go through the population of loans and say, ‘This could be a problem and how can we handle it?’ instead of throwing the loan into default,” she says. “This facilitates the conversation around loan modifications and restructurings.”
While loan origination volumes are down, the firm is seeing an increase in loan modifications, renewals and restructurings.
“Some lenders are trying to get some paper off of their books to free up their balance sheets, but others are recognizing these are strong assets with strong sponsorship that are being well run but are subject to inflationary pressures. It means lenders are not throwing out the baby with the bathwater because these are relationships the lenders want to maintain,” Brodeur adds.
As sponsors, servicers and lenders move to refinance or extend maturing loans and manage distress in other financings, SitusAMC is expecting to see private lenders play more of a role.
“We are starting to see some different ideas on capital structures and stacks. When private lenders became a larger part of the private credit market, we started to see a lot of innovation and I think we will start to see that continue over the next five years,” says Michael Franco, chief executive of SitusAMC.
Market participants who spoke with Real Estate Capital USA note there continues to be a disconnect between borrowers and lenders on pricing, proceeds and property valuations.
“Everyone on all sides of the table are trying to figure out what the game plan has to be. I don’t think there is a formula for workouts, it is being done on a deal-by-deal basis and I don’t see that shaking itself out until everyone comes to terms with where interest rates are going to be,” Rich adds.
“Everyone got smarter from the process of what was happening during the GFC and the pandemic. There is more negotiation that goes on now, and lenders and servicers are more willing to work with borrowers to solve problems.”
Workspace Property Trust is a Horsham, Pennsylvania-based real estate investment trust that owns and manages a portfolio of suburban office buildings.
In June, the REIT was able to extend roughly $1.3 billion of CMBS debt backed by 146 suburban office, light industrial, R&D and flex properties in 14 major US markets.
Working via New York-based consultancy Iron Hound Management Company, the firm was able to work with special servicer Key Bank to negotiate a two-year extension on the floating-rate loan. While the firm had to contribute fresh equity to the deal, the solid performance of its portfolio and the broader suburban office market made it possible for the loan to be extended, Thomas Rizk, chief executive, says.