Investors are shunning several types of commercial mortgage-backed securities, especially lower-rated bonds and those linked to shopping malls and hotels, as borrowers seek debt relief in the fallout from the coronavirus pandemic.
With most commercial real estate lending on hold and a dearth of buyers for existing mortgage bonds, some observers now expect CMBS issuance volume to decline significantly for the full year. That marks a reversal from the early months of 2020, when private-label U.S. real estate securitizations, including collateralized loan obligations, rose 34% year over year.
Following 2019 — the strongest year for U.S. CMBS issuance since the last financial crisis — market participants expected roughly 8% to 10% full-year growth at the start of 2020, Trepp LLC Senior Managing Director Manus Clancy said in an interview.
"Now, it wouldn't shock anybody if we were to see issuance drop 30% to 40%," he said.
The sell-off for CMBS was swift and concentrated in a mid-March period when U.S. cities began to lock down in an effort to slow the spread of the virus. In response, levered investors holding a variety of fixed-income assets, including high-yield securities, dumped CMBS in an effort to raise capital for margin calls and investor redemptions.
Dedicated CMBS buyers also stepped back amid the confusion, with banks and insurance companies becoming buyers of last resort, J.P. Morgan analysts said in a note. But because banks were restricted from snapping up discounted bonds by tight capital regulations, only insurers and certain well-positioned asset managers were in a position to invest, with a variety of attractively priced debt securities to choose from, the analysts wrote.
Pricing has stabilized for AAA-rated CMBS bonds in recent weeks as the U.S. government and the Federal Reserve have moved to support markets and the broader economy. But credit-default swap spreads, a measure of the perceived risk attached to different securities, have continued to widen for lower-rated bonds and those most closely tied to worrisome property sectors.
"With the economy sheltering in place for at least 45 days and probably longer, you're going to have some fundamentally harmed businesses," Edward Shugrue III, managing director and portfolio manager at RiverPark Funds, a CMBS investor, said in an interview. "Obviously retail. And then hotel. But I think one of the big differences is, retail was already in trouble, and this puts the nail in the coffin. ... When you've been home for two months, and you had to alter how you shop, it just fundamentally changes the way you do that forever."
Sectors of concern
One window into investor concern about retail properties is the price of swaps related to CMBX 6, an index backed by 2012-vintage CMBS deals. CMBX 6 is notably retail-heavy in comparison with other CMBX indices, and some prominent investors, including Carl Icahn, have moved to short it in recent months in a bet that the loans in the index would default.
As The Wall Street Journal first reported, Icahn's thesis got a boost — and retail proponents on the other side of the trade, including AllianceBernstein Holding LP and Putnam Investments LLC, got a setback — as a low-rated slice of CMBX 6 fell by more than 40% in late March. As of April 8, according to Trepp data, spreads on credit-default swaps for the BBB- tranche of the index stood at 1,881.5 basis points, more than 1,000 basis points wider than at the beginning of March.
Hotel-backed securitizations, too, are under scrutiny, with U.S. lodging properties posting historic year-over-year declines amid widespread property closures in response to the virus.
S&P Global Ratings analysts said in a note that lodging properties have historically exhibited the lowest net cash flow margins of any major property type, with the sector displaying some of the worst credit metrics of any property type in the recession following the last financial crisis.
According to lifetime loan performance data through June 2012, the agency said, the cumulative default rate for S&P-rated CMBS backed by hotels was 24.8% — the worst among major property types.
Hotel loans accounted for roughly 14% of conduit CMBS collateral so far in 2020, and 16% of collateral in single-asset single-borrower CMBS, down from a peak of 45% in 2017. With property performance data still scarce for the new crisis, the level of expected borrower defaults is unclear, S&P Global Ratings Senior Director Senay Dawit said in an interview, noting that CMBS underwriting in recent years has been more disciplined and conservative than in the years leading up to the last crisis.
"Obviously there's a liquidity issue going on," he said. "The big question is if that turns into a credit one."
Expectations of delinquency
In the two-week period ending March 29, more than 2,600 commercial real estate borrowers representing $49.1 billion of mortgage loans sought potential debt relief, Fitch Ratings said in a note based on a survey of the four largest CMBS master servicers. The figures included borrowers in 42 single-asset single-borrower CMBS deals secured by hotel and retail properties, and hotel assets accounted for about 47% of relief inquiries, followed by 30% for retail assets.
Questions remain about whether CMBS lenders, which at times have had a reputation among borrowers for inflexibility, will accommodate forbearance requests.
"I think the last crisis was a teachable moment for a lot of participants," Dawit said. While the "borrower experience" was an issue in the last crisis, he added, "servicers and master servicers, I imagine, would be more willing to work with the borrower to come up with a solution that makes sense."
Though lender flexibility depends in part on market conditions, "I don't think lenders are in any hurry to foreclose on these guys," Trepp's Clancy said. "I think they're saying, 'If I foreclose on this guy and take his property over, all I'm doing is taking his problems."
Real estate industry groups, meanwhile, pressed the Federal Reserve to expand its Term Asset-Backed Loan Facility to allow loans to buyers of some CMBS bonds — a request the Fed granted April 9. The move was intended to stabilize the CMBS market, but Shugrue, for his part, said some new buyers are emerging on their own, targeting bonds tied to property types that appear safer, such as industrial and office.
He said his own firm, which focuses on single-asset single-borrower securitizations, has been buying.
"At these prices, my view is, Tiffany never goes on sale, and we're going to Tiffany and buying at 10%, 15% off," Shugrue said. "I love that."