‘Adverse Selection’ Drives Higher Losses for Legacy CMBS

Adverse selection in the commercial mortgage-backed securities 1.0 universe of pre-2009 loans drove loss severities higher last year. reported Fitch Ratings, New York.

Loans that are less troubled loans have in the shrinking legacy loan universe have already paid off, leaving a higher percentage of problematic loans on the books.

Fitch’s annual U.S. CMBS loss study noted last year’s cumulative CMBS loss severities were in line with recent years at 45.6 percent compared with 45.9 percent in 2017. But the average annual loss severity rose to 42.1 percent from 35.6 percent in 2017 and nearly three-quarters of 2018 resolutions had losses exceeding 1.5 percent, up significantly from 2017. “The increased proportion of loans with losses reflects the higher proportion of adversely selected CMBS 1.0 loans among 2018 dispositions,” the report said.

Loan-level loss severities will likely remain high for most CMBS 1.0 assets that remain in special servicing, Fitch predicted. “The 2019 annual average loss severity may increase slightly as the most troubled of the remaining peak vintage REO are disposed,” Fitch Senior Director Karen Trebach said.

While post-2009 “CMBS 2.0” loan defaults are increasing, they remain low, mostly because they were underwritten at lower leverage, Trebach said. “Special servicing transfers are likely to increase over the next few years as early CMBS 2.0 loans approach maturity, though nowhere near the levels seen in the prior cycle,” she said.

For the fourth time in the past five years, retail loans led CMBS loss severities last year. “Retail CMBS losses will stay elevated with online retailers currying more favor with consumers and more store closures and bankruptcies likely among brick and mortar retailers,” the Fitch report said, noting office moved to second place with a 42 percent loss severity in 2018. Industrial and multifamily remained the only two property types with loss severity improvements since 2017.

Trepp, New York, noted the CMBS special servicing rate increased in April for the first time in 10 months.

“This is the first rise in the special servicing rate since July 2018 and it is the highest reading in the last two years,” Trepp Analyst Dylan Wall said. “While special servicing rates for all five major property types climbed last month, the retail sector featured the greatest month-over-month change.”

But despite April’s increase, the special servicing rate dropped 115 basis points year over year, Wall said.

The Trepp Special Servicing Report said 26 loans totaling $910 million transferred to special servicing in April. Retail loans made up 68 percent of that balance, far exceeding the other four major property types.

DebtX, Boston, said prices of commercial real estate loans underlying CMBS declined 97.8 percent at the end of April from 98.2 percent in March. Prices equaled 95.8 percent in April 2018.

“The decrease in loan prices in the CMBS universe in April was primarily the result of an increase in the Treasury yield curve,” DebtX Managing Director Will Mercer said.