The CMBS Market During the Pandemic: A Conversation with Moody’s Investors Service

MBA NewsLink interviewed Keith Banhazl, Victor Calanog and Nick Levidy from Moody’s, New York. Banhazl is a Managing Director within Moody’s Investors Service’s Structured Finance Group and leads the U.S. CMBS and CRE CDO/CLO Surveillance team. Levidy is Managing Director in the Commercial Real Estate Group at Moody’s Investors Service with responsibility for CMBS primary ratings. Calanog is Head of Commercial Real Estate Economics for Moody’s Analytics. Prior to the acquisition by Moody’s Analytics in October 2018, he served as Chief Economist and Senior Vice President of REIS.

MBA NEWSLINK: June remittance reports are coming in for commercial mortgage-backed securities transactions. Are there any general trends you would highlight in this month’s data?

KEITH BANHAZL: Coronavirus-related business disruptions led to an unprecedented increase in the delinquency rate in June 2020. Cash flow disruptions among retail and hotel properties drove what was by far the largest recorded one-month increase in delinquencies in conduit CMBS loans.

Our CMBS conduit loan Delinquency Tracker for loans delinquent 60+ days increased to 5.78% in June 2020 from 2.68% in May, a 311 basis point increase. The June rate was also the highest delinquency rate since January 2018. For historical context, the DQT peaked at 10.06% in July 2012, and the prior largest monthly increase was only 69 basis points in March 2010, when the lagged impact of the great financial crisis was manifesting in CMBS.  

It’s important to note that retail and hotel properties currently constituted 82.6% of the 60+ days delinquent loans in June. 

The share of conduit loans with a 30-59 days DLQ payment status remained flat at 4.3%. Barring forbearance or other modifications, we anticipate that many of the loans with a 30-59 days DLQ late payment status in June will become 60+ days delinquent in July and represent another sizeable increase in the overall delinquency rate which could approach the former DQT peak. 

NEWSLINK: This is the third month of CMBS data since COVID-19 shutdown started and fundamental commercial real estate performance seem to be lagging the broader economy. Do you expect that historical pattern to hold in this situation where the slowdown happened much more quickly than in past recessions?

VICTOR CALANOG: This is an important question, because this economic downturn is very much different. Yes, we are seeing lags in performance metrics like occupancies and asking rents: we are recording, at worst, a 10 basis point movement in worsening occupancies across sectors in the second quarter. That might be easily explained for sectors like multifamily, which, because of massive governmental support, for tenants, including eviction moratoria, is expected to fare relatively better than other property types. And for office properties, which are insulated by long-term leases. But it is less easy to explain for a property type like retail.

What’s happening is that we’re seeing a lot of landlords play a ‘wait and see’ game as the economy restarts. Even with headlines screaming retail bankruptcies, if for example, a JC Penney has not yet physically vacated a location or indicated that the space ought to be available for lease–that won’t show up in the occupancy numbers just yet. Where we are seeing cracks beginning to occur is on the effective rents side, where retail rents fell by 0.6% quarter over quarter. Even for multifamily, you’ve got markets like San Francisco recording a 3.3% decline in effective rents, its worst drop on record for a single quarter since the third quarter of 2001, when the area was hit by the twin stresses of the tech market bust and 9/11.

NEWSLINK: Several CMBS transactions have priced in the last two months. Commercial Mortgage Alert reported them as smaller than initially planned and without hospitality and retail collateral included. Do you anticipate any new issuance market resurgence in the second half of 2020? 

NICK LEVIDY: Spreads on CMBS bonds have tightened significantly since the peak of the coronavirus crisis in April. This is an important development for the CMBS market as it makes securitization loan rates more competitive, leading to a pickup in the origination of loans deposited in CMBS deals. Commercial real estate lending by CMBS conduit shops was frozen for several weeks at the end of March and into April, but it is starting to pick up again, a bullish indicator that we expect will result in an increase in issuance volumes in the third and fourth quarters of the year. 

Many deals that have recently come to market have been shaped to reduce the concentration of loans secured by discretionary retail and hospitality properties. Occupancy rates on hotels were starting to come back, but began falling again a couple of weeks ago, no doubt due to lingering concerns about the recent uptick of coronavirus cases in many states.  The coronavirus has accelerated the decline of regional malls and discretionary retail properties, while its impact on non-discretionary retail properties will be more muted.      

CMBS issuance through 1H2020 was about $30B (excluding Freddie Mac), frontloaded in the first three months of the year. The expectation for an increase in issuance volumes later this year is, of course, subject to the impact of exogenous events, most significantly the emergence of a serious second wave of the coronavirus. If such an event were to occur, the effect on interest rates, markets and the broader economy could choke off the nascent recovery we are currently seeing in CMBS.  

CALANOG: REIS data shows that commercial real estate property transaction volume in dollar terms fell by 42% in the first quarter relative to the fourth quarter of 2019. Transaction volume fell by another 46% in the second quarter. Expressed in a different way, transaction volume for the first half of 2020 has fallen by 46.6%, compared to the first half of 2019. Patterns are roughly similar across property types, so deal flow has really taken a pause because of the uncertainties surrounding this COVID-19-driven crisis.

I’m not convinced we will see a big bounce back in deal flow by the second half of the year given how economic reopening–and infection rates–have evolved. That means continuing challenges when it comes to selecting the right comparables to price a transaction.

NEWSLINK: Can you provide a high-level review of Moody’s CMBS rating actions March-June and any market trends or factors Moody’s views as key rating drivers?

BANHAZL: Rating actions over the last couple of months have been driven predominately by the exposure to hotel and retail loans, in particular lower-quality regional malls that have already experienced declining performance. The deteriorating performance of a mall pre-COVID is now compounded by further expected decline in performance as a result of store closures, weakened tenant credit profiles, re-opening uncertainty and in some cases the sponsor’s credit profile.

NEWSLINK: What have special servicing transfers looked like over the last three months?

BANHAZL: The impact from government-mandated store closures, travel restrictions and social distancing measures are continuing to disrupt operations for many properties backing CMBS loans, leading to large monthly increases in transfers into special servicing. 

Retail properties pushed Moody’s Specially Serviced Loan Tracker increase to 6.66% in June from 4.92% in May and 3.90% in April. The outstanding balance of specially serviced loans increased to $25.67 billion from $18.89 billion. The hotel sector SSLT increased to 14.61% in June 2020 from 9.24% in May 2020, while the retail sector SSLT increased to 10.64% from 7.65%. 

Many transfers to special servicing, particularly among Large Loan/Single Asset Single Borrower transactions, are a result of requests for forbearance or other temporary modifications. While a borrower may still be current on their debt service, the imminent inability to continue doing so causes them to request payment relief, or other modification of loan terms or reserve requirements in their loan agreements.

NEWSLINK: One challenge in the current environment is conducting appraisals and inspections. Logistically, but further still, valuing assets without the benefit of a functioning market with sales comps is problematic. Any thoughts to share on how to manage credit analysis and ratings when property valuation is arguably more subjective than ever?

CALANOG: As you noted, there are several layers to this issue, and it’s not just the difficulty of finding appropriate comparables. There is also the physical challenge of actually visiting a site (still necessary in this day and age despite satellite images and other technologies) to conduct proper appraisals and inspections.

On the positive side, as states reopen and some semblance of economic activity picks up, this will likely allow appraisers and other real estate service providers to go about their business with less constraints. When transaction activity slowed down in ’08-’09, our experience has been that valuation shifted from a focus on actual sales transactions to pillars of data that we could observe: namely, income drivers like trends in rents, occupancies and expenses. Indicative measures like rent collection losses will be key to trying to anticipate the trajectory of incomes. In addition, closer coordination between the brokerage firms and other parties privy to the transaction will be key: for example, can we observe how many unsuccessful bids there were versus the seller’s asking price, to get a sense of what buyers were willing to pay? This was key to valuing land sales in New York when the market dried up in ’08-’09.