Nearly everyone has played the game of musical chairs at some point in their lives. When the music stopped, the unfortunate participant who ended up without a chair at the end of a round had to sit out the rest of that game and wait for the next one to get another chance to play.
Surprisingly, commercial mortgage backed securities (CMBS) loans have a similarity to musical chairs. How can this be? A look at CMBS loan-delinquency trends helps to make sense of this analogy.
A deceptive decline Data indicates that these CMBS delinquencies are declining. But this raises the question of how these delinquencies are getting resolved. Have the root problems that led to the delinquencies been addressed, or is it really more like a game of musical chairs with delinquent CMBS loans as the participants being “eliminated”?
First, take a look at the facts and trends indicated by the accompanying chart. The amount of delinquent CMBS loans has declined steadily from an all-time high of more than $62.8 billion in 2011 to about $41 billion by the end of this past year, according to Trepp.
Many people would assume when noting such a drastic decline in the delinquent CMBS loans that the root causes behind the delinquencies have been solved in some way. But the truth is that often loans are modified to “live another day.” Sometimes they are foreclosed on and ultimately sold by the trust, sometimes they are liquidated via a discounted payoff or short sale and other times they were simply “eliminated from the game,” as in musical chairs.
Behind the numbers In all of these scenarios, the problem loans in question were not resolved, but instead sold to other lenders to handle from that point forward. They were no longer technically delinquencies — they just became someone else’s problem. This was done through both one-off and large note sales. In fact, in 2012 more loans were transferred out of special servicing because of note sales than modifications or reinstatements.
For example, CMBS special servicer ORIX Capital Markets LLC sold nearly $1.5 billion of notes in spring 2013, followed by CWCapital offering more than $2.5 billion of notes at a note auction later this past year. In addition, there were note auctions of smaller amounts by special servicers almost every month throughout this past year, which resulted in the appearance of much lower CMBS delinquency rates by the end of the past year. It is tempting to conclude (incorrectly) that problem loans…