CMBS Default and Delinquency Rates: What Borrowers Should Know
While CMBS lenders’ underwriting standards are stricter than they once were, a certain amount of conduit loan borrowers still default on their loans. It’s generally understood that a loan default is something that borrowers want to avoid at all costs. However, understanding the CMBS default rates-- and, just as importantly, the reason why borrowers defaulted on their loans in the first place, can be essential for borrowers who want to avoid the same fate.
CMBS Default and Delinquencies: The Basics
While CMBS lenders’ underwriting standards are stricter than they once were, a certain amount of conduit loan borrowers still default on their loans. It’s generally understood that a loan default is something that borrowers want to avoid at all costs. However, understanding the CMBS default rates-- and, just as importantly, the reason why borrowers defaulted on their loans in the first place, can be essential for borrowers who want to avoid the same fate.
The Three Types of CMBS Defaults
Before getting deeper into default statistics and explanations, borrowers should understand that there are actually three major types of default that can occur when a borrower has a conduit loan. These include:
Term default: The most common type of CMBS default, this occurs when a borrower simply cannot make their interest payments (or, if the loan is partially amortizing, the principal and interest payments).
Maturity default: The second most common type of CMBS default, maturity defaults occur when a borrower cannot refinance their conduit loan at maturity, leaving them with a large “balloon” payment that they typically cannot afford to pay.
Technical default: The least common type of CMBS default, technical defaults happen when a borrower is up to date on their loan payments, but has violated some aspect of their loan agreement, or their loan’s Pooling and Servicing Agreement (PSA). For instance, they may have taken on a new tenant without first consulting their Master Servicer.
General occupancy/vacancy issues
Borrower problems
Demand issues
Maturity default
Technical default
Single-tenant vacancy
Property damage
What is a CMBS loan and how does it differ from other types of commercial real estate financing?
A CMBS loan, or commercial mortgage-backed securities loan, is a type of financing that is provided by lenders who package and sell mortgages on to commercial mortgage-backed securities (CMBS) investors. These investors then receive the mortgage payments from borrowers. CMBS loans can be advantageous because they don’t require much scrutiny of a borrower. Rather, the loan is underwritten on the financial strength of the asset held as collateral.
CMBS loans are generally provided with fixed interest rates and have terms of five to 10 years, with amortization periods of up to 30 years. They are available for most types of commercial real estate assets, but they may be harder to come by in smaller markets. This type of loan can be used to fund an acquisition or for a refinance.
CMBS loans differ from other types of commercial real estate financing in that they are securitized and sold to investors on the secondary market. Lenders tend not to scrutinize borrowers too closely, instead prioritizing the asset and its cash flows in making a decision. CMBS loans can be a good option for borrowers with bad credit, as they offer more flexibility, lower interest rates, and do not require a personal guarantee.
What are the current CMBS default and delinquency rates?
Right now, the CMBS default rate is at the lowest it’s been in 20 years. According to a 2018 study by the Kroll Bond Rating Agency (KBRA), more than one half of the CMBS defaults over the last two decades were from loans originated between 2005 and 2008, a period representing the last years of the real estate boom and the 2007-2008 financial crisis.
A 2019 analysis by Fitch Ratings, a major credit rating firm, showed that, for CMBS loans originated after 2009, loans issued by nonbank lenders had significantly higher default rates than those issued by banks. In fact, the analysis showed that, for the period analyzed, non-bank conduit loans had 2.3% default rate, nearly double the 1.2% default rate for bank CMBS loans.
What factors influence CMBS default and delinquency rates?
The most common reasons for loan default are general occupancy/vacancy issues, borrower problems, demand issues, maturity default, technical default, single-tenant vacancy, and property damage. According to a 2018 study by the Kroll Bond Rating Agency (KBRA), more than one half of the CMBS defaults over the last two decades were from loans originated between 2005 and 2008. A 2019 analysis by Fitch Ratings showed that, for CMBS loans originated after 2009, loans issued by nonbank lenders had significantly higher default rates than those issued by banks. Additionally, groups of conduit loans with higher LTVs and lower DSCRs experienced defaults at higher rates than those with lower leverage and higher DSCRs.
What strategies can borrowers use to reduce the risk of CMBS loan default?
Borrowers can reduce the risk of CMBS loan default by following a few key strategies. First, borrowers should ensure that their loan-to-value (LTV) ratio and debt service coverage ratio (DSCR) are as low as possible. This will help to ensure that the loan is not over-leveraged and that the borrower has enough cash flow to cover the loan payments. Additionally, borrowers should be aware of the most common reasons for loan default, such as general occupancy/vacancy issues, borrower problems, and demand issues, and take steps to mitigate these risks. Finally, borrowers should consider working with a bank lender, as loans issued by banks have a lower default rate than those issued by non-bank lenders.
What are the benefits of CMBS loans for commercial real estate borrowers?
CMBS loans offer commercial real estate borrowers a variety of benefits, including flexible underwriting guidelines, fixed-rate financing, and fully assumable loans. Additionally, lenders and bondholders can potentially achieve a higher yield on investments, and investors can choose which tranche to purchase, allowing them to work within their own risk profiles.
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Recent Analysis Shows Non-bank CMBS Lenders Have Higher Default Rates
A 2019 analysis by Fitch Ratings, a major credit rating firm, showed that, for CMBS loans originated after 2009, loans issued by nonbank lenders had significantly higher default rates than those issued by banks. In fact, the analysis showed that, for the period analyzed, non-bank conduit loans had 2.3% default rate, nearly double the 1.2% default rate for bank CMBS loans. In all likelihood, this simply indicates is that banks underwrite conduit loans more strictly than non-bank lenders-- and is not a valid reason for borrowers to avoid speciality CMBS shops.
The most common reasons for loan default were:
While all these issues are serious, occupancy problems, borrower problems, and demand issues accounted for nearly 70% of all defaults. Perhaps unsurprisingly, Fitch’s analysis also indicated that groups of conduit loans with higher LTVs and lower DSCRs experienced defaults at higher rates than those with lower leverage and higher DSCRs.
Other CMBS Default Trends
Right now, the CMBS default rate is at the lowest it’s been in 20 years. According to a 2018 study by the Kroll Bond Rating Agency (KBRA), more than one half of the CMBS defaults over the last two decades were from loans originated between 2005 and 2008, a period representing the last years of the real estate boom and the 2007-2008 financial crisis. Overall, research also indicated that office and hotel properties had the two highest levels of loan defaults, which is also somewhat unsurprising, due to the fact that these property types are often impacted by economic fluctuations than more stable property types, such as multifamily.
Special Servicers Often Make CMBS Defaults an Onerous Process
While a loan default is never pretty, potential CMBS borrowers should be aware that the CMBS default process can be especially unpleasant, due to the fact that borrowers will not be working with their original lender. Instead, they will work with a special servicer assigned to them in their loan’s pooling and servicing agreement (PSA). While lenders generally want to make a reasonable effort to help a borrower become current on their loan, this is not always the case with special servicers, whose main duty is look out for investor profits. As they often have the right to purchase a foreclosed property at a discount, some less-than-ethical special servicers may actually push for a quick foreclosure-- hoping to add the property to their own portfolio.
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