CMBS Loans Face Few Refinance Hurdles
A total of $109.6 billion of CMBS mortgages are up for refinancing over the next two years, with $57.6 billion coming due in 2020 and $52 billion the following year. Single-asset, single-borrower CMBS transactions represent 66 percent of this total, while conduit loans account for 29 percent. These are two of the largest deal types in CMBS.
Short-term loans against hotels account for $31.7 billion, or 28.9 percent of the total coming due. That’s the result of the heavy acquisition and brand consolidation activity within the hotel segment in recent years. Office and retail comprise 21.6 percent and 23.2 percent of the total coming due, respectively.
While interest rates have remained extremely low for the past two years, helping keep the incidence of maturity defaults low, the risk is that rates will increase, which could lead to a rise in defaults. (The 10-year Treasury yield stood at 1.8 percent as of mid-January compared with 2.7 percent a year earlier.)
Analysis & Findings
Trepp has reviewed the $31.6 billion of conduit loans maturing from now through 2021 and examined whether they would pass certain refinancing thresholds based on prevailing loan-to-value (LTV) and debt-service coverage ratios, as well as debt-yield requirements. We removed from our universe loans marked as delinquent, fully defeased and those tied to properties generating negative net operating income (NOI), leaving a sample size of $26.3 billion.
To generate updated debt-service coverage ratios and appraised collateral value for the maturing loans, we calculated average coupon rates, based on property type and geography, and paired that with the most recently reported NOI data. In each case, the geographic thresholds were used only when they were less restrictive than the average rates for the property type overall.
We assumed maturing loans would be taken out by loans that do not amortize, and we calculated appraised collateral values using average capitalization rates from recent loan originations. Those appraised values were also used to make LTV calculations. As an additional test, current debt yields were computed using most recently available NOI data and outstanding loan balances.
With these new loan performance metrics calculated, new debt-service coverage ratios and LTV figures were then determined according to several rate-hike assumptions. In the case of the debt-yield test, the threshold for qualifying for a full refinancing was raised by the assumed interest-rate increase.
The criteria used for passing each refinancing test were customized based on lending trends specific to the corresponding metropolitan statistical area and property type. Generally speaking, property values decline and debt-service requirements increase as interest rates increase, assuming all other variables remain the same.
On average, conduit loans issued over the second half of 2019 carried a coupon of 4.2 percent, down from 5.1 percent during the latter half of 2018, while cap rates fell 51 basis points during this period to just under 6.5 percent (see table).
At the same time, underwriting metrics strengthened in 2019. The average conduit debt yield climbed to 14.4 percent, while the debt-service coverage ratio, a measure of cash flow being generated by the property relative to its annual debt obligations, trended up to 2.5, just as leverage dipped to 59.1 percent over the past six months. This compares to origination averages of 11.7 percent, 1.8 and 61.9 percent for these respective categories during the second half of 2018.
If current rates hold steady, 85.3 percent of conduit loans maturing through 2021 (by balance) would meet their respective debt service coverage ratio requirements. From the same pool of loans, 64.3 percent would pass their debt-yield thresholds and 69.6 percent would clear their LTV hurdles, with more than 64 percent qualifying for refinancing under all three tests.
This is a notable improvement from a similar analysis conducted at year-end 2018, which examined the refinancing outlook of outstanding loans that were scheduled to come due by 2020. The pass rates for debt-service coverage ratio, debt yield and LTV based on prevailing rates at the time were 74 percent, 59 percent and 64 percent, respectively, while almost 60 percent of conduit loans were considered refinanceable by all three measures.
While the outcome may be surprising given the higher refinancing thresholds that must be met, based on 2019’s underwritten metrics, it could be reflective of the stronger credit performance of today’s outstanding loans as somewhat weaker legacy securitizations continue to be resolved.
If interest rates were to increase by 50 to 100 basis points, however, the volume of maturing CMBS loans that would meet each refinancing measure would fall by 5 to 15 percent. Increases in interest rates would result in the most significant percentage of loans being eliminated from the LTV refinanceable bucket, while the debt-yield hurdle has the lowest pass rates for each interest-rate assumption. The debt-service coverage ratio test proved to be the qualification barrier that was easiest to hurdle.
From a property-type standpoint, an increase of 25 basis points in interest rates would shuffle the largest percentage of multifamily assets out of refinancing potential, while hotel loans generally would have the most difficulty in reaching any origination parameter used. Industrial, on the other hand, boasts the highest share of loans that would be eligible for new financing.
The bottom line is that as the credit characteristics of CMBS loans remain at sound levels and property fundamentals continue to hold up, the mortgage sector, and CMBS specifically, should remain in calm waters, even if interest rates climb.
— Catherine Liu, Research Associate,Trepp LLC. This article first appeared in the January/ February issue of Northeast Real Estate Business.