CMBS Delinquency Rate Drops, Loss Severities Increase

Michael Tucker

September 11, 2018

The commercial mortgage-backed securities delinquency rate fell again in August for the sixth consecutive month, but large loans liquidated with high loss severities drove up the second quarter's loss severity figure, analysts said.

The CMBS delinquency rate fell 17 basis points to 3.64 percent last month, a new post-crisis low, said Trepp Senior Managing Director Manus Clancy. "As the remaining legacy debt continues to be resolved and more new loans are issued into the pipeline, the reading can be expected to maintain its downward trajectory," he said.

Clancy noted geopolitical events, trade negotiations and the upcoming midterm elections provide investors with plenty of drama, "[but] the CMBS market continues to be largely drama-free," he said. "Thanks to continued delinquency rate improvements and a solid pace of new issuance, the CMBS market in 2018 remains healthy and volatility-free for issuers and investors."

Despite the delinquency rate drop, Moody's, New York, reported large loans liquidated with high losses increased the quarter's loss severity. Out of 106 loans liquidated during the quarter, seven had a liquidation balance greater than $20 million and a loss severity above 65 percent, which contributed to a weighted average loss severity of 66.7 percent, up significantly from 39.1 percent for the 100 loans liquidated in the first quarter.

Moody's said three notably large loans were liquidated with a full loss during the quarter. The Galleria at Pittsburgh Mills loan was liquidated with a $149.1 million loss. And the Empirian Multifamily Portfolio Pool 1 - B note and the Empirian Multifamily Portfolio Pool 3 - B note were both liquidated with a full loss of $115.4 million and $99.1 million, respectively. These three loans accounted for nearly one-third of the quarter's total loss.

Brian Olasov, Executive Director of Financial Services Consulting with Carlton Fields, New York, said much of the loss data confirms conventional wisdom. "Longer workout periods produce higher losses, larger loans in bigger metros tend to have lower loss severities and lending on the second regional mall in a one-mall town produces dismal outcomes," he said. "But among the nearly 12,000 loans experiencing losses from 1998 forward, there are always notable exceptions. These exceptions underscore the risks in moving away from skilled, experienced underwriting towards automated, rules-based lending."

Olasov noted recent Morningstar Credit Ratings research shows something else. Morningstar said the balance of loans on its "Watchlist" reached a 13-month high $25.2 billion in July, up $816.7 million from June. Declining performance among office and multifamily properties drove the increase. This metric reached a post-crisis low $17.34 billion in November 2017.

"After nine benign years in commercial real estate debt, some cracks are inevitably forming," Olasov said. "Informal discussions with special servicers support this trend. Likewise, specially serviced loan volumes are ticking up. While the vast majority of the special serviced universe derives from legacy CMBS, CMBS 2.0 transfers are ticking up admittedly from a low base."

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