CMBS Delinquency Rate Reduction Accelerates; Possible 'Inflection Point' Ahead?

Michael Tucker mtucker@mba.org

October 04, 2018


The commercial mortgage-backed securities delinquency rate dropped "markedly" once again in September, reported Trepp, New York.

The CMBS delinquency rate has now fallen in six straight months and 14 of the past 15 periods, Trepp Senior Vice President Manus Clancy said. "While the reading has consistently slid lower for more than a year, the speed of the improvement accelerated in September."

Clancy called the drop the biggest in four months and the third-largest this year.

Trepp reported persistent distressed legacy debt resolutions and sustained new loan securitizations drove the delinquency rate down 23 basis points from August to 3.41 percent.

September's delinquency rate is 199 basis points lower than a year ago and breaks the previous post-crisis low of 3.64 percent set in August. The reading peaked at 10.34 percent in July 2012. "The delinquency rate could crack the 3 percent level before the end of 2018," Clancy said.

Morningstar Credit Ratings, New York, said it expects the delinquency rate on loans packaged in commercial mortgage-backed securities to remain below 2.5 percent for the remainder of the year, but noted its growing watchlist suggests that forward-looking risk is increasing, possibly signaling a delinquency rate "inflection point."

"Liquidity in the commercial lending market remains strong, a trend that we expect to continue through the fourth quarter," Morningstar Assistant Vice President of Credit Risk Services Ricky Cipko said in the firm's Fourth Quarter Market Outlook. "Pockets of traditional risk warrant monitoring; however, we do not anticipate large systemic issues for some time."

But Morningstar said over the longer term, the delinquency rate will likely gradually increase as post-crisis deals season. "We believe the rate will reach an inflection point in 2019 or 2020," the report said. "The burning off of legacy loans has been a significant factor in the steady decline in recent years, though its impact will fizzle, with the legacy balance representing just 4 percent of the universe today and declining rapidly."

In addition, Fitch Ratings, New York, noted net operating income for commercial properties it studies increased 1.9 percent on average last year, down significantly from 2016's 3.4 percent overall NOI growth. Year-over-year NOI changes equaled 3.3 percent in the multifamily sector from 2016 to 2017 compared to 5 percent from 2015 to 2016 and in the industrial sector the NOI growth figure fell to 2.4 percent compared to 4.4 percent between 2015 and 2016. NOI slipped -0.9 percent for hotels from 2016 to 2017, unchanged from the 2015 to 2016 time frame.

Brian Olasov, Executive Director with Carlton Fields, New York, said Fitch's research reinforces a "top-of-market feel" to many real estate sectors. "Given that there's an adverse selection bias among reporting borrowers--healthy properties are likelier to share operating results as opposed to weak properties--the 60 percent of respondents likely overstate overall growth."

At a modest 1.9 percent NOI growth, a more comprehensive view is probably close to flat, Olasov said. "What happens when flattening NOI begins losing its footrace against rising cap rates? Values decline," he noted.

Olasov said Fitch appears to be calling an end to performance increases when it describes various sectors as either peaked or peaking. "To be clear, this doesn't signal a rollercoaster-style precipitous decline from the top," he said. "The more likely near term outcome is an environment with flat revenues. These flat revenues may be undermined by inflating operating expenses."

In particular, labor costs at many properties may accelerate from a confluence of immigration pressures, tightening labor markets and progressive employers setting new minimum wages of $15 per hour, Olasov said.

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