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.

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:

• General occupancy/vacancy issues

• Borrower problems

• Demand issues

• Maturity default

• Technical default

• Single-tenant vacancy

• Property damage

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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