CMBS Loans Have Gone To Special Servicing This Year Faster Than Ever Before
The number of CMBS loans in the U.S. that have become delinquent and been transferred to special servicing this year is at the highest level since the aftermath of the Great Recession.
Most of those loans have been in the hardest-hit hotel and retail sectors, reflecting the almost-overnight disruption the coronavirus pandemic has caused to travel and shopping habits. Those segments are now at new peaks for delinquency.
Across property types, loans are going to special servicing faster than during prior recessions, taking months instead of years and rocketing the overall market toward its previous peak at an unprecedented rate.
Overall, the percentage of loans sent to a special servicer firm reached 10.48% in September, according to global securities data provider Trepp. That figure came down slightly to 10.28% in October, but remained well above the pre-pandemic rate of 2.78% in January.
In CMBS terms, the hardest-hit asset type has been hotels. About 26% of all lodging loans were in special servicing in September, Trepp data showed. That rate fell to 25.45% in October, but it was still far higher than the special servicing rate of 1.94% at the beginning of the year.
Retail came in next, reaching a rate of 18.32% in September before coming down to 18% in October, compared with the January rate of 5.06%. In stark contrast, office, multifamily and industrial have each had less than 3% of their CMBS loans in special servicing since the beginning of 2020.
Both the hotel and retail special servicing rates in September are the highest on record, according to Trepp.
The unexpected and global nature of the pandemic had a fast and furious effect on the U.S. economy. As shutdown periods began to take effect in March, businesses were forced to close or scale back, and many tenants found they could not afford to pay rent. That lack of cash flow has meant that some landlords and borrowers are now facing delinquency issues of their own.
A senior executive at a major financial institution who oversees CMBS special servicing activity told Bisnow that the pandemic had an almost instantaneous effect on the market, as businesses were forced to close and many people found themselves swiftly unemployed.
“It was dramatically faster and deeper in its impact than what we experienced back in the Great Recession,” said the executive, who asked to remain anonymous to speak freely about sensitive loan matters.
Hotels and retailers were already facing some headwinds that were further exacerbated by the pandemic. The hotel sector was going through an unprecedented level of new construction, while e-commerce was starting to cut into the performance of brick-and-mortar retail.
“I think these things have come together, unfortunately, right at the same time and accelerated some things that otherwise may have been problems on a smaller scale and would have played out over a longer period of time,” the executive said.
Trepp’s CMBS delinquency rate, which represents the number of loans that have missed at least 30 days of payments, rose from 2.14% in January to 10.32% in June. That rate fell in the subsequent months, arriving at 8.28% in October.
Trepp research analyst Jyoti Yadav told Bisnow that the last time the industry saw high CMBS delinquency rates was in the aftermath of the Great Recession. However, those rates took around four years to reach a gradual peak in 2012. The swift and dramatic economic impact of the pandemic meant that in 2020, it only took four months.
“It took four months in this crisis to reach the same high, whereas in the last crisis, that was four years. So it's definitely, definitely very fast,” Yadav said.
A CMBS loan can be sent to special servicing for a variety of reasons. A common scenario is when a borrower has fallen behind on its mortgage repayments and becomes delinquent. Other reasons include, but are not limited to, low occupancy, unpaid property taxes or the poor condition of the property.
When a loan becomes genuinely distressed, there isn’t much that can be done at the master servicer level, according to JLL Capital Markets Vice President Kyle Kaminski. For any material implementation of debt restructuring, true forbearance or exploration of other options, a borrower needs to send its loan to a special servicer firm.
Kaminski noted he has seen an increase in the number of CMBS loans being transferred to special servicing at the request of the borrower before delinquency and significant distress are at play.
“They want to talk to somebody on the other end of the phone and discuss potential options, let them know. That has to happen at the special servicer level, it doesn't happen at the master servicer level,” Kaminski said. “In most cases, the master [servicer], there isn't a warm body on the other end of that line.”
Yadav said borrowers requesting a transfer to a special servicer is common when they are experiencing difficulties.
“The borrowers know that they need the special servicer to execute any kind of forbearance or modifications or forgiveness, etc., so they ask for the transfer to try to kick-start that process,” Yadav said.
The executive at the major financial institution who handles CMBS activity noted that the volume of borrowers seeking to transfer their loans to special servicing this year may have been exacerbated by consultants looking to get hired on to help “grease the skids” at the special servicer level. However, in most cases, this does not add much value.
“They were running around out there telling borrowers that step one is you’ve got to get your loan transferred to a special servicer, because you can't get anything done otherwise, and that's not altogether accurate,” the executive said.
One alternative option that has seen a dramatic increase in 2020 is forbearance agreements in which the lender agrees not to foreclose on a mortgage and the borrower agrees to a payment plan that will eventually bring it up to date on its loan.
Forbearance agreements also allow borrowers to use cash reserves that are typically off-limits to bring debt service payments up to date. Yadav said forbearance agreements are relatively new to the CMBS market and have appeared on a large scale this year because of the pandemic. In its October CMBS delinquency report, Trepp estimated that more than $30B in loans in the private market have been granted forbearance.
The forbearance agreement route is only intended to be a short-term accommodation. The executive said about 500 have been done this year where the borrower has used existed financial reserves to make service payments. It’s possible to take that route first, without resorting to special servicing.
“The vast majority have been able to be done without a formal transfer to the special servicer,” the executive said.
Though the volume of CMBS loans going to special servicing has skyrocketed during a very short period, Kaminski said that generally, borrowers and lenders have a better understanding of how to navigate the structure to find solutions.
“CMBS as an investment vehicle and as a debt instrument is more mature now. So people are much more familiar with the nuances surrounding it, as opposed to when we were going through the Great Recession,” he said.
The timeline for recovery in the CMBS market is uncertain. Yadav said the speed and shape of that recovery will be dependent on the broader economy, including when a vaccine is produced. It will also vary by property type.
However, given the number of forbearance agreements that have been implemented, overall recovery could take an extended period of time.
“It is possible that once these forbearance agreements expire, the economy has already bounced back and everything goes back to normal,” Yadav said.
“However, if the forbearance agreements expire, if then some of the loans are supposed to mature [and] the economy hasn't [come] back and we are still seeing widespread issues, then it will take much, much longer to recover.”
Another senior executive with a major financial institution told Bisnow that new CMBS issuances are starting to happen again, and the makeup of those borrower pools is moving away from hotels and retail in the near term. The executive asked to remain anonymous to discuss sensitive financial matters.
“I think [at] a non-agency or private label CMBS, the investors are speaking, the lenders are providing capital to borrowers with property types that the investment community has some confidence in. So you see the makeups of the pool, they're changing away from retail and hotel for the near term,” the executive said.
“I think that the market is speaking as to what's an acceptable product, with the right risk characteristics to that.”