Deep End of the CMBS Pool: A Conversation with KBRA Analysts

The quickly soured commercial mortgage-backed securities market, with pockets of challenged hotel and retail collateral properties in markets scattered across the country, is the commercial real estate story of 2020. The good news is that the new issuance market has not completely shut down like it did in the last recession and agency MBS is continuing full steam ahead with relatively resilient performance to date for multifamily.

Further, CMBS delinquencies seem to have peaked and have headed down from their highs. KBRA just released its 2021 Sector Outlook: CMBS: Slow and Steady report. As the real estate finance industry grapples with increased infection rates approaching the holiday season and how to think about 2021, MBA NewsLink sat down with KBRA’s Patrick McQuinn and Sacheen Shah to get their insights.

Patrick McQuinn is a Senior Director in KBRA’s CMBS new-issuance group. He is the lead analyst on conduit and CRE CLO transactions and oversees the analysis and presale publication of Freddie Mac K-series transactions for the firm. Prior to Kroll, McQuinn worked in asset management at Arbor Commercial Mortgage and was a civil engineering associate at architecture and engineering firm HGBD.

Sacheen Shah is a Director in KBRA’s CMBS new-issuance group. He focuses on the analysis of commercial real estate loans and on the publication of presale reports. Before joining Kroll, Shah worked as an associate director in GE Real Estate’s balance sheet debt originations group and was a full-time underwriting consultant in Citi’s CMBS conduit group. He also held positions at M&T Bank and as a corporate banking associate at Citi.

MBA NEWSLINK: 2020 has been a surprising and challenging year for commercial real estate. Can you walk through KBRA’s CMBS and CRE CLO rating activity since March of this year?

McQUINN, SHAH: CMBS issuance started strong the first two months of 2020 before COVID-19 began to meaningfully effect the CRE market at the beginning of March, temporarily halting issuance. Activity subsequently resumed, with the first conduit launching in May. In general, issuance has picked up as the year has progressed.

Sacheen Shah

Here is a breakdown of KBRA-rated deals by transaction type starting in Q2, which generally shows an increasing number of deals per quarter:

  • Conduit: KBRA rated four in Q2, five in Q3, and expects to rate six through year-end 2020.
  • SASB: KBRA rated one in Q2, two in Q3, and three through year-end 2020.
  • Freddie: KBRA rated three in Q2, two in Q3, and four through year-end 2020.
  • CRE CLO: KBRA rated one in Q2, zero in Q3, and one through year-end 2020.

NEWSLINK: What are some predictions or key takeaways you’d like to highlight from your 2021 CMBS Outlook?

Patrick McQuinn

McQUINN, SHAH: We expect CMBS issuance to be approximately $60 billion in 2021, which is slightly higher than the projected year-end level in 2020 of approximately $53 billion to $55 billion. While estimating future issuance is always a challenge, the current environment is making any projections extremely difficult. In determining our estimate, we considered multiple factors including CMBS loan maturities, 2020 volume, and the current interest rate environment.

A lack of demand for hotel and non-essential retail will continue to keep CMBS issuance from the growth seen in years prior to the pandemic.

We expect activity to be at relatively low levels at the start of 2021, with a pickup as the year progresses, particularly if a viable vaccine is introduced to the broader public.

Among the major property types, we expect demand to remain strong for loans secured by multifamily assets, industrial (more specifically last-mile distribution centers), certain pockets of office that have tenants with good credit and essential retail.

Regarding credit metrics for KBRA-rated conduit loans, leverage is down in 2020, while interest-only periods are up. As of October 2020, over one-third of the loans originated since April 2020 were structured with a debt service reserve. While this level is considerable, it appears to be trending down as the year progresses based on recent KBRA-rated deals.

During 2020, KBRA effectuated more than 3x the combined number of downgrades from all the previous years since KBRA has been rating CRE securitizations. Despite this, 93.8% have been affirmations and less than 1% of all high investment-grade (A, AA, and AAA) categories have been affected.

NEWSLINK: Any expectations on pool size, credit trends or collateral composition you can elaborate on?

McQUINN, SHAH: We have generally been seeing smaller conduit pools since the start of the pandemic. This appears to be driven by fewer lodging and retail loans contributed to CMBS deals, which combined represented over one-third of conduit pools in 2019. If a vaccine is widely available in 2021, retail and lodging loan originations could rebound and the size of conduit pools could begin to increase. 

In-Trust KBRA LTV (KLTV) trended down to 94.1% YTD 2020 after two years of edging higher. The All-In Cutoff KLTV, however, continued to increase and reached 105.5%, its highest level since 2017. This was driven by an increase in the number of loans with subordinate debt, which grew to an all-time high of 43.7% versus 28.5% in 2019. Its previous peak was 31.0% in 2017.

The KBRA IO Index, which provides a measure of a transaction’s exposure to interest-only loans, increased to 81.9% in Q1 2020 from 65.8% in full year 2019. The index trended down in Q2 and Q3 2020, before settling at an average of 79.0% by year-to-date November 2020. This trend has tracked the proportion of full-term IOs, which also increased in the first quarter before dropping in Q2 and Q3. KBRA Debt Service Coverage (KDSC) as of YTD November 2020 increased sharply to 2.67x from 2.08x in 2019, its highest since KBRA started tracking in 2012. This year’s KDSC figure has been influenced by the rising IO exposure.

The pandemic has had significant negative impacts on the retail and lodging sectors, both of which were seeing signs of weakness prior to COVID-19. The retail and lodging exposures continued the decreasing trend seen last year and dropped to 16.5% and 9.4% of conduits in YTD November 2020, respectively. KBRA would expect these exposures to remain flat or decrease further in 2021 unless a vaccine is widely available.

The highest property type exposure YTD November 2020 is office (41.2%), followed by multifamily (16.8%). Multifamily exposure surpassed retail for the first time since 2012. Freddie Mac has maintained a strong pipeline during 2020, and the lender’s market share could affect conduit property type concentrations through the end of this year and into 2021. Industrial exposure, at 9.8%, increased for a fourth consecutive year.

NEWSLINK: What are you most optimistic about in terms of new issuance over the next 12 months? Conversely, can you expound on your views on nonessential retail and lodging, which you mentioned earlier have experienced a lack of demand during the recession?

McQUINN, SHAH: We are encouraged by news of multiple vaccines getting close to being submitted for approval by the FDA. If one or multiple vaccines are available in early to mid-2021, this could support demand for hotel and “experiential” retail properties, which could in turn lead to growing CMBS issuance.

Although industrial and multifamily assets have not been immune to the effects of the pandemic, these asset classes have seen relatively stable rent and occupancy trends during 2020, compared to some of the other major property types. We expect these two asset classes to continue to be the strongest performers in 2021 among the major property types. However, both sectors are expected to see significant additions to supply in 2021, which could put downward pressure on occupancy and rent.

With respect to office, the impact from the pandemic is still yet to be determined. Fundamentals have not deteriorated as quickly as some other property types as office leases tend to be longer term, which provides some protection from the immediate impacts of the pandemic. However, companies are continuing to evaluate their needs for office space along with work-from-home solutions that may have a longer-term impact on occupancy and rent.

For hotels, COVID-19 has disproportionately impacted higher end (luxury, upper-upscale, and upscale chain scales), 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 demand for hotel rooms will not return until a vaccine is widely distributed. If a vaccine is distributed in early to mid-2021, it is anticipated that demand may begin to return in summer 2021.

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. These include grocery stores, convenience, discount/dollar, hardware, mass merchandisers/superstores, and off-price apparel stores along with fast food and quick-service restaurants.

NEWSLINK: Retail and hospitality defaults have been challenges for outstanding CMBS transactions. How has this affected your outstanding KBRA-rated portfolio?

McQUINN, SHAH: In March, KBRA issued reports on the Single-Asset Single-Borrower and Large Loan transactions backed by retail malls and lodging loans, and we assessed the transactions at Underperform due to the pandemic. In July, KBRA placed 146 classes across 41 conduits on Watch Downgrade, and many of these had higher levels of lodging (14.6%) and retail (31.1%) loan exposure. And then in October, we placed 12 ratings across six SASB and LL lodging transactions on Watch Downgrade.

In total, KBRA effectuated 204 downgrades this year, more than 3x the combined number of downgrades from all the previous years since KBRA started rating CRE securitizations. In addition, KBRA placed another 95 ratings on Watch Downgrade. Nearly all of the downgrade actions and Watch Downgrade Placements were concentrated in CMBS conduit, SASB, and LL transactions. In these deals, most of the certificates that were downgraded or remain on Watch (73.6%) were previously or–if on Watch–are currently rated below investment grade.

While these actions and Watch Placements have affected 21.4% of our BB and 30.2% of our B ratings, it has only impacted 9.2% of BBB classes and less than 1% of all high investment grade (A, AA, and AAA) categories. Despite the record number of downgrades, the overwhelming number of rating activity comprise KBRA affirmations, which account for 93.8% of all rating actions. This compares to 95.7% for the same period last year.

At this time, we believe that the bulk of negative rating actions will continue to be associated with mostly non-investment grade and low investment-grade classes.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at; or Michael Tucker, editorial manager, at