The on-again, off-again European debt crisis coupled with investor concerns over a potential pricing bubble for trophy properties in the U.S. has taken a toll on the commercial mortgage-backed securities (CMBS) market. As bond investors demanded higher yields for perceived higher risks in the third quarter, loan originations tapered off.
The turbulence is creating an additional problem. The delinquency rate for CMBS loans rose 21 basis points to 9.77 percent in October, the second highest level ever, according to New York-based Trepp LLC. Only the 9.88 percent reading in July of this year was higher.
After dipping significantly in August, the delinquency rate has now increased for two straight months. Trepp considers a loan delinquent if it is 30 days or more past due.
The lodging sector experienced the biggest setback with the delinquency rate rising from 13.30 percent in September to 14.12 percent in October. The multifamily sector, which most investors are bullish on because of favorable demographics and the meltdown of the single-family home market, still has the highest delinquency rate at 16.73 percent (see table).
“The hope always is that the CMBS market's health will result in some of the loans on the cusp actually refinancing their way out of their problems,” explains Manus Clancy, senior managing director of Trepp.
But when the CMBS market is on the rocks, two issues emerge, he points out. “Properties that are marginal, but not severely underwater, have one less avenue to pursue. And new loans that come to maturity have one less possible source of refinancing.”
How jittery are CMBS investors? The swap spread for 10-year, triple-A CMBS soared from 179 basis points on July 8 to 339 basis points on Oct. 7 before receding to 283 basis points by Oct. 28. (Spreads are the difference in yield between a bond and its benchmark, in this case the swap rate.)
The roller-coaster ride for CMBS spreads during the past several months is due to a confluence of factors, concluded Trepp researchers in their monthly delinquency report.
“Many CMBS investors began to whisper that the impressive rally in CMBS from mid-2010 through May 2011 had taken the market too far, too fast. At the same time, commercial real estate professionals made similar comments about the lofty pricing of trophy properties in the U.S. earlier this year.”
News of layoffs at CMBS loan origination and trading shops on Wall Street stung the market further in October. Spreads continued to race upward, ultimately hitting their highest levels since mid-2010, according to Trepp.
Then just as quickly, the CMBS spreads contracted in late October following word that European leaders had tentatively agreed to a grand plan to financially bail out Greece. But that situation remains fluid and the outcome is uncertain.
One of two scenarios is going to unfold during the next six months, says Clancy. “If the delinquency rate goes higher, it will obviously be because there has been a new wave of distressed properties, or loans reaching maturity that can't be refinanced. If the delinquency rate goes down, it will likely be because special servicers sold off weak properties at losses.”
Total domestic CMBS issuance in 2010 was $11.6 billion, according to Commercial Mortgage Alert. Total volume this year was initially projected to range between $40 billion and $50 billion, but the final tally may very well fall short of that projection. Year-to-date through Oct. 27, total domestic issuance was $27.7 billion.
To put those figures into context, consider that in 2007 total domestic issuance was $230 billion at the peak of the market.
— Matt Valley