May’s remittance reports painted a grim picture of the state of borrowers backing CMBS deals. The percentage of loans that are 30 days or more behind on payments went from 1.3% in April to 5.6% this month, according to Bank of America analysts.
Loans on hospitality and retail properties drove the figure upwards, with a jump of 16.5% of hotel loans and 7.1% of retail loans reporting delinquencies, compared to just 3.3% of multifamily and 1.5% of office loans.
Other data points to worse pain ahead for CMBS. As many borrowers are still in their 30 day grace periods, the true magnitude of commercial mortgage delinquencies may not be revealed for a few months.
“If we assume that a large portion of troubled borrowers that missed their monthly payment obligations last month will continue to do so, loans currently in their 30 day grace period will become 30 days delinquent,” wrote BofA analysts led by Alan Todd in a report this week. “If this were to occur, the 30-plus day delinquency rate could surpass [the rate] following the global financial crisis and become the highest on record.”
The pandemic’s battering of the retail and hospitality industries in particular is driving delinquencies, with these landlords representing the largest share of CMBS borrowers requesting forbearance in April. According to BofA, these loans also represented the largest percentage that are behind on payments, but under the 30 day threshold to be reported as delinquent.
“This may serve as the canary in the coal mine regarding the extent to which delinquencies increase next month,” Todd wrote.
‘Drinking from the firehose’
Whereas commercial landlords with multifamily properties financed through Fannie Mae and Freddie Mac have been granted a reprieve by the government as long as they do not evict tenants, private CMBS borrowers are at the mercy of special servicers. The entities tasked with working out defaulted loans have a number of tools they can use to cure defaults.
However, sources say that the sudden spike in delinquencies has caught servicers off guard. Following an economic boom that saw a dwindling amount of work for these asset managers, some firms have been overwhelmed.
“Some of these guys are already drinking from the firehose,” said a commercial real estate attorney, referring to the sudden surge of work special servicers are dealing with. “You’ve had a situation where there’s been a bull market for the last basically 10 years, and there are not as many people working at these firms as there were a few years ago.”
“The master servicer is not in a position where they can do anything in terms of forbearance. The borrower needs to get in front of the special servicer,” said Stephen L’Heureux, vice-president and global commercial real estate and CMBS strategist at investment manager Loomis Sayles & Co. “We’re seeing people petition the special servicer to get on their list.”
Sources said the servicing issue will be the real test of the CMBS market in coming months. The infrastructure in place to deal with defaulted loans was already a friction point before the pandemic, with borrowers reporting high levels of dissatisfaction with their experience compared to balance sheet financing from other sources of debt capital.
If the months and years following the 2008 financial crisis are any indicator, the workouts ahead could be long and painful, depending on the duration of the downturn. Investors say they are worried about the return of “extend and pretend”, with servicers extending loan maturities in the hope of a turnaround for troubled properties at some point in the future.
The rise in the number of people working from home has also caused anxiety. The retail and hotel sectors could rebound easily when the economy reopens, but the future of office properties is in doubt. Offices have long been a stable source of loans bound for both conduit and single asset-single borrower CMBS, but there is a growing bearishness on the asset class as the crisis continues.
In a paper from freelance and outsourcing company Upwork, chief economist Adam Ozimek noted that the pandemic “arguably represents the most drastic and rapid shift in the global workforce that we have seen since World War II”.
By most metrics, remote working has been a success. Companies have reported similar or increased productivity and workers have reported higher satisfaction compared to commuting into the office. Over 60% of companies surveyed by Upwork said they expect their organisation’s workforce to work remotely “significantly” or “somewhat more” than before the pandemic.
This is all leading CMBS market players to ponder the fate of the asset class if landlords find themselves in widespread renegotiations with tenants that require much less space in the post-pandemic era.
“With high rises there are so many questions,” said L’Heureux. “What do you do about lobbies and elevators? Do you have allotted times for travel? All of that uncertainty is going to linger after this.”