Andrew Foster: Top Five Commercial Mortgage Servicing Issues to Watch in 2021

Andrew Foster is Associate Vice President in MBA’s Commercial/Multifamily Group. He is a former Analyst with S&P Global Ratings and Fitch Ratings as well as a regular contributor to MBA NewsLink and MBA Commercial/Multifamily NewsLink. Foster can be reached at afoster@mba.org or 202/557-2740.

While most will be monitoring increased infections and the progress of vaccine distribution and effectiveness, loan servicing and asset management professionals will have some additional factors impacting their organizations and books of business in the new year.  

The first half of 2020 was perhaps best classified as a pivot to a predominantly portfolio management environment for most lenders with the market for new originations beginning to pick up somewhat for the balance of the year. Lending operations expect continued originations to pick up as the recovery prospectively gains more traction; however, market attention will remain on the back end of the business as existing loan challenges are addressed. We have quickly shifted from analogies about what inning of the baseball game we are in to analogies detailing which letter of the alphabet best describes the recovery. 

More letter recovery analogies in the new year is the prediction herein made with the highest degree of confidence. Regardless of whether we are in a K-shaped, V-shaped or any other letter-shaped recovery, below are five key issues for commercial mortgage servicers heading into 2021.

• Short-Term Forbearance Programs Mature. While plenty of commercial real estate collateral continued to perform this year, many borrowers have had trouble making their payments with retail and hotel borrowers the most challenged. As 2020-negotiated forbearances continue to expire, the market will get a sense of which borrowers were able to weather the pandemic with forbearance and use of reserves to cover debt service and which have further difficulties to manage through. “The way special servicers look at the vaccine news is, ‘Does this make the CMBS borrowers more likely to commit new capital to protect their equity? Will they now be more apt to commit capital?’” said James Shevlin, President and Chief Operating Officer of CWCapital. “We hope the answer is yes, as some borrowers are in round two of forbearance.” Read more details here.
  
• Hardening Insurance Market Dynamics. The 2019 pricing landscape for property and casualty insurance gave way to a new reality in 2020 as insurance markets reduced capacity, tightened terms, and delivered some of the steepest premium increases on record, said Servicer Council Vice Chair Laura Smith at Newmark.
  
  Already struggling with unsustainable loss activity, the insurance market was also forced to confront challenges associated with COVID-19, a rolling shutdown of the global economy, historically low interest rates, natural catastrophes and civil strife. Second-quarter renewals saw some of the largest pricing increases since 2003, led by Umbrella/Excess Liability, Directors and Officers Liability, Property, and Commercial Auto. This trend is likely to continue through 2022, although the rate of increase should begin to moderate by late 2021. Any prediction, however, is clouded by ongoing uncertainty. MBA’s Insurance Regulatory Committee is drafting a white paper to be released in first-quarter 2021 exploring the implications of these changes for loan servicers and lenders.

• Commercial Mortgage Stress in the Time of COVID. Commercial and multifamily mortgage loan performance improved for the second straight month in October, driven by fewer new loans becoming delinquent. 94.6% of outstanding loan balances were current, up from 94.3% in September according to MBA’s CREF Loan Performance Survey. However, more than 1,400 CMBS loans totaling $29.3 billion are currently delinquent, Morgan Stanley said. Lodging and retail properties have the highest delinquencies, at 22.6% and 11.8%, respectively.

To make things more complicated, the overall CMBS headline delinquency rate of 7.8% “may be understated by 300 to 400 basis points, given a combination of forbearance and borrowers drawing down on reserves to pay current principal and interest payments,” the report said. Read more details here. As many landlords struggle, Trepp estimates that about 5.5% of the non-agency CMBS universe—more than $31.2 billion across 800 loans—have been granted forbearances thus far, based on September remittance data. Moving past forbearance impact on headline numbers, in October, Trepp pinpointed about $3.9 billion in almost 100 outstanding CMBS loan balances where the borrower has indicated a willingness to turn over the asset to the lender.

• Minding the Storefront. While the number of delinquencies and defaults have been a focus this year given the volatility, with CMBS showing the most strains and transparent data, a clear focus in 2021 will be managing watchlists and ongoing portfolio surveillance. Surveillance of property types and market performance will be a significant task. 2020 challenges are known; however, commercial real estate generally lags the broader economy, and the impact of pandemic-challenged economic environment will be ongoing. How will office and multifamily perform? Is the worst over for hospitality and retail? 

KBRA recently shared their house views with MBA Newslink, “for hotels, COVID-19 has disproportionately impacted higher end (luxury, upper-upscale and upscale chains), large group and urban hotels. This has been especially apparent in gateway cities, many of which had large outbreaks that led to temporary hotel closures. Economy and midscale hotels had the smallest declines in performance. Weekend business was supporting the lodging industry’s recovery over the summer, but now that the summer holiday season is over and weekday business travel is still weak, hotel performance is expected to reverse some of these positive trends. Overall, we believe that rooms demand will not return until a vaccine is widely distributed.”

The retail sector, especially nonessential retail, is clearly facing headwinds, as there is no clear driver for the reversal of the negative trends observed since the start of the pandemic other than a vaccine. Although many department and other retail stores would have closed gradually over the next decade due to social preference changes, these retailers will likely experience an accelerated demise amid the pandemic, including permanent closures. The pandemic has also decelerated many of the trends that had been driving leasing demand through “experiential” tenants like restaurants, gyms, and play areas. These business types have been some of the most affected by social distancing mandates; however, these tenants are expected to stage a rebound following distribution of an effective vaccine, given pent-up consumer demand for recreational opportunities and other activities outside the home. The story in retail is not all negative. Retailers that focus on necessities and value-oriented items should benefit from recent shifts in behavior.

• Policy Changes, Eviction Moratoria and Stimulus.  From the CARES Act to CDC Eviction Moratorium or those issued in states, cities and counties across the country, 2020 has been extremely active on both the legislative and regulatory fronts. Upon the expiration of the Moratorium at year end, millions of Americans could face eviction. The only reason that is not happening already is the CDC’s Eviction Moratorium order and a patchwork of state and local protections for renters.

But moratoriums do not solve the problems created by COVID-19 fallout and can even worsen negative outcomes. For landlords stuck in the middle, there has been little relief, as they have had the following role to play — subsidizing housing for millions even as property taxes, monthly mortgage payments, and other expenses must be paid. Without Congress passing renters’ assistance or other stimulus, landlord subsidies are one of the few things helping keep Americans housed. However, part of the issue with moratoria is that back rent and late fees are accumulating and servicers are and will be on the front lines of addressing this situation however it plays out. Read more here.

Tim Steward of Midland Loan Services recently shared in an interview with MBA Newslink, “Things are very fluid right now and how we deliver our services is evolving in response to COVID-19 induced changes. New requirements are coming at us from all angles and it is very challenging to stay ahead of the curve. Some of the changes are relatively straightforward such as those associated with the updated CREFC IRP (8.1). Freddie Mac and Fannie Mae have proscriptive forbearance programs that servicers need to understand and follow. Other measures create more serious issues for servicers such as state orders and legislation which can potentially restrict lender/servicer actions and remedy options.”