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U.S. CMBS Update Q2 2022: Persistent Headwinds, Lower Debt Coverage, And Reduced Issuance

(Editor's Note: This is S&P Global Ratings' ninth quarterly update on U.S. commercial mortgage-backed securities transactions published with the backdrop of the COVID-19 pandemic.)

COVID-19's Continuing Impact

As of the end of June, the overall delinquency (DQ) rate for U.S. commercial mortgage-backed securities (CMBS) transactions was 2.6% and has steadily declined--albeit with a minor bump up in June--since peaking around 9% in the summer of 2020. Although the overall DQ rate has declined, the share of delinquent loans that are 60-plus-days delinquent (i.e., seriously delinquent) is high, at about 91%. The lodging and retail sectors still maintain the highest 30-plus-day delinquency rate, now between 5% and 6%, while office is at 1.5%, and industrial and multifamily are below 1%. We believe office, especially the class B subsector, will face ongoing challenges in the hybrid work environment. On June 9, 2022, we published "U.S. Single-Borrower CMBS Reviews Show Common Themes And Mixed Outcomes," which details not only our current view by property type, but also the myriad rating actions that took place earlier in the second quarter.

SASBs Continue To Lead Issuance

Single-asset single-borrower (SASB) transactions continued their trend of driving private-label CMBS issuance in the second quarter, with 11 deals totaling about $14 billion, easily outpacing $6 billion from conduits. The deal count was significantly lower. An increase in both short-term and long-term interest rates may shake up the current dominance of floating-rate SASB offerings, especially if rates are expected to continue their upward march. That said, the many uncertainties challenging markets and the broader economy might leave borrowers opting to stick with short-term floaters despite the outlook for rates.

The property-type exposure for SASBs continues to evolve coming out of the pandemic. In the second quarter of 2021, SASB issuance was dominated by office collateral, accounting for over 40% of volume, with industrial in second at nearly 20%. The remainder was a mix of mostly multifamily and lodging, with a small amount of retail.

Chart 1

image

First- and second-quarter 2022 showed some similarities and differences to second-quarter 2021: Industrial/self storage remains active, while office has faded. There were also higher retail, lodging, and mixed use/other concentrations, generally in larger-sized deals. And while some of the "other" category comprises mixed use, which includes office, market concerns about the future demand for space have clearly had an impact on volumes.

In total, just 11 SASB transactions priced in the second quarter, following 26 in the first quarter. Of those, we rated two and provided preliminary feedback on six.

Table 1

Summary Of S&P Global Ratings-Reviewed SASBs(i)
Weighted averages Q2 2022 Q1 2022 Q4 2021 Q3 2021 Q2 2021 Q1 2021
No. of transactions reviewed 6 20 22 19 20 15
No. of transactions rated 2 5 12 9 7 5
Average deal size (mil. $) 1,740 615 747 547 853 513
S&P Global Ratings LTV (%) 108.2 128.7 116.4 112.7 122.9 114.9
S&P Global Ratings cap rate (%) 8.4 7.8 7.6 8.3 7.8 7.3
S&P Global Ratings NCF haircut (%) (19.1) (15.4) (16.1) (17.0) (19.5) (16.8)
S&P Global Ratings value variance (%) (45.5) (45.9) (47.7) (43.4) (43.3) (42.2)
Floating-rate/fixed-rate (%) 100.0/0.0 79.0/21.0 95.4/4.6 79.0/21.0 85.0/15.0 80.0/20.0
(i)The statistics within this table reflect only those deals that we reviewed. LTV--Loan-to-value. NCF--Net cash flow.

Elevated SASB leverage continues to be a concern for us. In general, when we decline to provide preliminary feedback on a deal (six instances in the first quarter, five in the second), it is due to high leverage. We believe increased leverage is more a reflection of growing debt levels as opposed to our valuation opinions, which have remained more or less constant at (45)% in the second quarter, averaging in the (42)%-(48)% range for the past six quarters. Table 2 provides a summary of deals we reviewed in the quarter by property type.

Table 2

Summary Of S&P Global Ratings-Reviewed SASBs By Property Type
Retail Office Lodging
No. of transactions reviewed 2 1 3
No. of transactions rated 0 0 2
S&P Global Ratings LTV (%) 84.5 129.2 113.1
S&P Global Ratings cap rate (%) 6.6 7.8 10.4
S&P Global Ratings NCF haircut (%) (8.9) (17.3) (28.5)
S&P Global Ratings value variance (%) (34.0) (49.9) (51.7)
Primary markets (%) 29.4 87.8 23.7
Secondary markets (%) 70.6 12.2 74.3
Tertiary (%) 0.0 0.0 2.0
Floating rate (%) 0.0 0.0 0.0
Fixed rate (%) 100.0 100.0 100.0
LTV--Loan-to-value. NCF--Net cash flow.

The two deals we rated in second quarter were both backed by lodging properties--a portfolio of Red Roof Inns and a luxury resort in Boca Raton.

Mixed Metrics For Conduits

The largest change in loan metrics for conduit new issuance transactions was in debt service coverage (DSC), largely resulting from rising interest rates. Here are the key points comparing the first and second quarters:

  • Overall loan-to-value (LTV) was little changed, down 30 basis points to 96.2%. There was a wide dispersion in deals we rated and those we didn't; the average LTV for the two rated transactions was 86.7%, while the average of the five we didn't rate was 99.6%.
  • The DSC ratio declined more than 0.3x to 2.03x. We note that historically low interest rates and high interest only (IO) loan percentages clearly contributed to recent elevated DSC ratios. That said, the 10-year U.S. Treasury yield has increased, and the pool level metrics reflect this. Declining DSCs will also warrant higher subordination levels.
  • Combined IO percentages remained high, at 87%, and the full-term IO percentage set a new post-Great Financial Crisis (GFC) quarterly record, at 78.6% of pools (eclipsing last quarter's print by 10 basis points).
  • Our average cash flow and value variance to issuer values both were about the same, reflecting an average 16% cut to NCF and about 40% to value.
  • Effective loan counts (as measured by the Herfindahl-Hirschman Index [Herf] score) were down, as were average deal sizes and loan counts.

Our 'AAA' And 'BBB-' Credit Enhancement Levels Were Well Above Market Levels

Our 'AAA' and 'BBB-' credit enhancement levels were about five points clear of the actual market levels. We continue to believe these 'BBB-' rated classes could prove relatively more vulnerable to event risk--especially with more concentrated pools/smaller deal sizes. As a result, we have not rated many of these classes in recent vintages.

Of the seven conduit transactions that priced in second-quarter 2022, we rated two (see table 3). The seven offerings had an average of 47 loans, with top-10 loan concentrations rising a whopping 480 basis points quarter over quarter, to 57.9%.

Table 3

Summary Of S&P Global Ratings-Reviewed Conduits(i)
Weighted averages Q2 2022 Q1 2022 Q4 2021 Q3 2021 Q2 2021 2020 2019 2018
No. of transactions reviewed 7 9 8 7 9 28 52 42
No. of transactions rated 2 5 6 5 7 14 36 19
Average deal size (mil. $) 859 1,102 985 1,118 953 888 926 915
Average no. of loans 47 53 61 72 55 44 50 50
S&P Global Ratings' LTV (%) 96.2 96.5 98.5 98.5 93.4 93.7 93.5 93.6
S&P Global Ratings' DSC (x) 2.03 2.36 2.35 2.28 2.48 2.39 1.93 1.77
Final pool Herf/S&P Global Ratings' Herf 23.2/31.8 26.4/37.5 26.4/29.7 33.1/43.2 26.6/29.2 24.1/33.1 27.7/33.7 28.1/36.3
% of full-term IO (final pools) 78.6 78.5 73.6 66.9 73.1 70.7 61.6 51.7
% of partial IO (final pools) 8.5 11.0 14.3 15.6 15.7 17.9 21.4 26.2
S&P Global Rating's NCF haircut (%) (15.7) (15.8) (17.0) (16.0) (15.2) (15.8) (13.4) (13)
S&P Global Ratings' value variance (%) (40.4) (40.5) (43.4) (41.1) (40.7) (40.0) (36.0) (35.3)
'AAA' actual/S&P Global Ratings CE (%) 21.2/26.1 19.8/22.3 21.7/23.2 21.7/22.1 21.3/21.4 20.4/22.9 20.8/24.3 21.0/26.0
'BBB-' actual/S&P Global Ratings CE (%) 7.1/12.5 6.6/11.4 7.6/13.1 7.3/12.0 7.1/10.6 6.8/11.4 7.0/10.8 7.1/10.9
(i)S&P Global Ratings' credit enhancement levels reflect results for pools that we reviewed. Actual credit enhancement levels and other market statistics within the table represent every deal priced within a selected vintage or quarter, not just the ones we analyzed. LTV--Loan-to-value. DSC--Debt service coverage. Herf--Herfindahl-Hirschman Index score. IO--Interest-only. NCF--Net cash flow. CE--Credit enhancement.

The conduit deals priced during second-quarter 2022 had slightly lower LTV ratios and considerably lower DSCs on a quarterly basis. The average LTV was 96.2%--a 30-basis-point decrease. The dispersion between the average LTV within the two deals we rated to the five that we didn't was quite wide, at about 13 points.

Average DSC fell 0.33x to 2.03x in the second quarter, as interest rates have risen. This still somewhat high DSC level is largely due to a lot of full-term IO loans. For the purposes of our DSC analysis regarding partial IO periods, we utilize the figure after the IO period ends, but partial IO percentages remain somewhat low. We should note that, unlike our SASB rating approach, which is driven by recovery assumptions and as such focused on leverage, our conduit approach looks at both leverage and DSC ratios, among other factors, in determining probability of default assumptions. Accordingly, continued reductions in pool level DSCs will, along with leverage and Herf score, continue to affect required subordination levels as they did in the second quarter.

IO as an overall percentage of the collateral pools fell to about 87% in the second quarter from 89.5% in the first. Full-term IO loans made up 78.6% of the collateral pools--a new 2.0 (post-GFC) quarterly record.

In our review, we make negative adjustments to our loan-level recovery assumptions for all IO loans. In some conduit transactions, we make additional pool-level adjustments when we see very high IO loan concentrations or when an IO loan bucket has no discernible difference in LTV versus the average. The average S&P LTV for full-term IO loans issued in first-quarter 2022 was about 98.4%--213 basis points above the overall average.

Effective loan counts, or Herf scores, which measure concentration or diversification by loan size, were down over 300 basis points to 23.2. This reduction also reflects the increased top-10 loan concentrations mentioned above. The average deal size fell somewhat sharply, off $243 million to $859 million in second-quarter 2022, while the average number of loans fell to 47, from 53 in the previous quarter (and 61 in fourth-quarter 2021).

Property Type Exposures Continue To Shift Within Conduits

We continue to see some movement in conduit deal property-type compositions from quarter to quarter. Industrial exposure was up a bit at 9%, though it has come off the highs from last year, which averaged about 12% across the vintage. Retail exposure was 22% in the second quarter, up from 18% in the first quarter. Concentrations have been steadily rebounding from their pandemic lows (just below 10%) in the second and third quarters of 2020. Lodging rose slightly to 6%, from 5% last quarter. While leisure travel has rebounded significantly, urban centers and convention hotels remain weak.

Although headlines about the future of office and hybrid work arrangements abound, this hasn't dampened the concentrations of the property type in conduits. The second quarter saw 40% of collateral backed by offices, off from 43% in the first quarter. Meanwhile, multifamily exposure fell four percentage points to 11%. Of the five major property types, multifamily has the second lowest delinquency rate at just 0.7% as of June 2022 (industrial has the lowest at 0.4%). Self-storage accounted for about 6% of pools, representing about half of the "other" category in chart 2.

Chart 2

image

Issuance Likely To Struggle

There was about $21 billion in second-quarter 2022 private-label CMBS issuance (excluding commercial real estate CLOs). The breakdown between SASB and conduit in second-quarter 2022 was again roughly two thirds/one third, or $14 billion SASB/$6 billion conduit, plus a couple of other deals. Our annual forecast of $110 billion in January has since been lowered to $90 billion, and headwinds abound, leading us to look for something in the $70 billion-$80 billion range. Long-term interest rates have risen pretty sharply although they've remained relatively rangebound of late, spreads across structured finance (and CMBS is no exception) are wider, inflation remains stubbornly high, and the probability of recession (especially in 2023) is far higher than it was when 2022 began.

Related Criteria

This report does not constitute a rating action.

Primary Credit Analyst:Senay Dawit, New York + 1 (212) 438 0132;
senay.dawit@spglobal.com
Secondary Contacts:Rachel Buck, Centennial + 1 (303) 721 4928;
rachel.buck@spglobal.com
Mark Jacobs, Centennial +1 3037214926;
mark.jacobs@spglobal.com
James C Digney, New York + 1 (212) 438 1832;
james.digney@spglobal.com
Ryan Butler, New York + 1 (212) 438 2122;
ryan.butler@spglobal.com
Global Structured Finance Research:James M Manzi, CFA, Washington D.C. + 1 (202) 383 2028;
james.manzi@spglobal.com

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