Bulk sales key to CMBS delinquency rate and investor fortunes


The US CMBS delinquency rate has been falling month after month since last summer. The recent CWCapital REO auction and note sale will help to fuel that trend and is expected to spark further bulk liquidations, with a mixed impact on investors.


The CMBS delinquency rate peaked at 10.34% in July 2012, but has fallen consistently over the last eight months, reaching 7.25% at the end of January. As well as liquidations, increased CMBS demand and recovering property values have played an important part in reducing delinquencies.


“The peak in 2012 was caused by a real confluence of events. In the first half of the year there were a lot of 2007-era loans coming due. Many of those loans were over-levered and had trouble refinancing, so they contributed greatly to the delinquency rate,” says Joe McBride, CMBS research analyst, Trepp.


He continues: “In the second half of the year, that wave of maturing loans subsided. But there was still a lot of uncertainty concerning the fiscal cliff at the end of that year and the uncertainty of continued Fed stimulus.”


While the delinquency rate is declining fairly evenly for all property types, there are some differences. The retail sector has the lowest delinquency rate at 6.16%, while multifamily has the highest at 10.67%. There are also discrepancies among vintages.


“The overall delinquency rate may be 7.25%, but for 2006 and 2007 CMBS it is in double figures; loans in 2007 vintage CMBS deals have a rate of 12.35%. While some vintages have not kept pace with the others, continuing bulk sales will see the rate come down,” says McBride.


The CWCapital portfolio liquidation could be enough to move the CMBS delinquency rate below 7%. The sale accounts for nearly US$2.6bn of delinquent loans in special servicing – although while these loans are being moved out of CMBS trusts, they are not always leaving the broader commercial real estate market.


“What servicers are essentially doing is offloading billions of dollars’ worth of CMBS into another part of CRE. So, while CMBS defaults are coming down rapidly, in the wider CRE market it is a different story,” says Ann Hambly, founder and ceo, 1st Service Solutions.


Hambly notes that large note sales such as the CWCapital auction benefit the buyers that get a good deal on distressed notes and the special servicers that realise a quick fee, but not necessarily the bondholders who are left in the stack or the owners of the underlying real estate. “Often those owners have actually made better offers than what the trust got in the note sale,” she says.


Additionally, there may be conflict-of-interest issues generated by the fact that it is the special servicer which both makes the decision to conduct bulk sales and also most benefits from them. However, for as long as bulk sales remain in the interests of special servicers, they are likely to continue.


“That conflict of interest is a real problem. CMBS 2.0 has attempted to address this by the addition of the operating advisor, but for the CMBS 1.0 deals, this is something we will keep seeing until these are all flushed through,” says Hambly.


Early indications from the CWCapital sale suggest that the prices paid by at least one buyer – Starwood Capital Group – were better than expected (SCI 30 January). Implied loss severity on the loans is 50.4%, which is around 10 percentage points lower than ARA-implied severity, while the purchase price was also 26% higher than the most recent appraisal value would have suggested.


While borrowers and bondholders may well be worried about best execution, the CWCapital prices appear positive. “If the early indication is that sales were at considerably more than expected values, then it is hard to argue that value has not been passed through to the trust,” says John Lonski, capital markets vp, Cornerstone Real Estate Advisers.


He continues: “For the most part, the data has not so far supported the idea that best execution is not being achieved. That situation might change in the future, but while bulk sales are realising better than expected outcomes they will continue to be used.”


Other large special servicers will inevitably have been keeping tabs on the CWCapital sale and may consider taking the same approach. Especially as servicers come to the end of their involvement with the assets, the temptation to earn one last fee before a change of bondholder control leads to a change of servicer will be strong.


With more bulk sales expected, previous ones such as the CWCapital auction provide an insight into what secondary market investors can expect. Largely, the impact on investors will depend on where they are positioned in the capital stack.


“It is interesting that we have both senior investors and more subordinated investors taking note of these sales. Senior investors are worried about negative convexity; while their bonds are trading at a premium to par, those senior noteholders are in no rush to see a return of principal,” says Lonski.


He continues: “However, while the senior classes are looking more at how much it will hurt their yield, the subordinated investors are looking at it from the opposite perspective. Further down the capital stack, bondholders are looking at upside scenarios.”


The CWCapital assets purchased by Starwood comprised 11 loans backed by 14 properties across four CMBS deals: BACM 2007-1, GSMG 2007-GG10, MLCFC 2007-5 and WBCMT 2006-C28. Initial loss estimates would see the class J and L notes of GSMG 2007-GG10 – which is the deal with the highest exposure to the sale – wiped out.


The CWCapital sale is expected to flow through in February’s remittances, almost certainly continuing the monthly delinquency rate decrease. The rate is expected to pass 7% soon and could reach 6.5% by year-end.


“The market has turned a corner, although there are still hurdles like QE tapering and a wave of maturing loans that the market will have to digest,” McBride concludes. “As long as demand for CMBS bonds stays high, banks will keep writing loans on properties and refinancing activity will stay high. We are in a much better place than a year ago.”


This article was published in Structured Credit Investor on 6 February 2014.


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