S&P Global Ratings continues to closely monitor COVID-19's impact on U.S. commercial real estate fundamentals and its ratings on U.S. commercial mortgage-backed securities (CMBS), particularly in the lodging and retail sectors (see "U.S. Lodging-Backed CMBS Bracing For The Impact Of COVID-19," published March 23, 2020). We remain in constant dialogue with market participants, including servicers, to gather all relevant information as this unprecedented pandemic and resulting economic shutdown unfold (see "U.S. Commercial Mortgage Servicers Preparing For Impact From COVID-19," published April 3, 2020). We expect CMBS loan performance will vary significantly by property, market, and borrower, and we will continue to track each rated transaction and take individual rating actions, as appropriate. While this edition of our quarterly report differs from past editions, we continue to provide our insight of CMBS credit metrics, as well as an analysis related to an investor inquiry, including segmented average S&P Global Rating loan-to-value (LTV) ratios for loans in the 2019 CMBS conduits we rate.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak around midyear, and we are using this assumption in assessing the economic and credit implications. In our view, the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

COVID-19's Evolving Impact

Our conversations with master servicers to date indicate a surge in requests for relief from borrowers, primarily related to lodging and retail properties. Many of these requests are for temporary payment forbearance, but others are more significant and would involve a permanent loan restructuring. Servicers are evaluating each request and assessing whether a special servicer transfer is appropriate. While still early, we continue to analyze the data as it comes in via remittance reports or from conversations with the servicers.

From a ratings standpoint, our immediate concern is liquidity and the timely payment of interest. Following a payment default, servicer advancing can prevent interest shortfalls to the rated notes, perhaps even during a short-term forbearance period. Longer term, however, advancing will likely be reduced or curtailed following an appraisal event on more distressed properties, which would lead to interest shortfalls to the trust. Since our ratings assess the timely payment of interest, we could take negative rating actions, based on our assessment and the framework outlined in our temporary interest shortfall criteria (see "Structured Finance Temporary Interest Shortfall Methodology," published Dec. 15, 2015).

Although all CMBS property types are likely to be negatively affected by COVID-19, we believe lodging and retail will feel it most acutely. We currently rate 375 U.S. CMBS transactions: 192 single-asset/single-borrower (SASB) and large loan transactions and 183 diversified conduits. Of the 192 SASB and large loan transactions, 37 (19.3%) are collateralized by lodging properties and 45 (23.4%) are backed by retail assets. Within the conduit space, eight of the 183 transactions have lodging exposure greater than 20%, while 60 have retail exposure greater than 30%.

New Issue Credit Metrics Generally Improved In Q1

The loan metrics for U.S. CMBS conduit new issuance transactions generally improved in the first quarter:

• Debt service coverage (DSC) ratios continued to rise largely due to lower long-term interest rates and a higher percentage of full-term interest-only (IO) loans, which rose to almost 75% of collateral pools.
• Leverage fell by five percentage points quarter over quarter and effective loan counts remained stable.
• By property type, multifamily and office concentrations declined quarter over quarter, while lodging and retail increased.

Our Required Credit Enhancement Levels

Our 'AAA' credit enhancement level was slightly above 20% in the first quarter, compared to the market average of slightly above 19%. Our 'BBB-' credit enhancement level was approximately 9%, compared to the market average of about 6%. We believe these 'BBB-' rated classes could prove relatively more vulnerable to event risk--and at a heightened level--until the ultimate economic impact of COVID-19 on CMBS performance becomes clearer.

We rated seven of the 10 U.S. CMBS conduit deals priced in first-quarter 2020 (see table 1). The 10 transactions that priced had an average of 50 loans, with top 10 loan concentration averaging 50% of the pool balance.

Table 1

The conduit deals priced during first-quarter 2020 had significantly lower LTV ratios and higher DSC ratios on a quarterly basis. The average LTV was 90.1%--a 500 basis points (bps) decrease quarter over quarter. Average DSC increased 0.3x to 2.42x in the first quarter, maintaining a rising trend from 2019. This likely reflects two factors: lower interest rates and more full-term IO loans. (Note that for the purposes of our DSC analysis regarding partial IO periods, we utilize the figure after the IO period ends, but partial IO percentages have been declining.)

IO as an overall percentage of the collateral pools rose to 90% in the first quarter from 84% in the third quarter. Full-term IO loans now make up 74% of the collateral pools, a 720 bps increase quarter over quarter, while partial term IO exposures fell 90 bps to 16.6%.

In our review, we make negative adjustments to our loan-level recovery assumptions for all IO loans. In some conduit transactions, we make additional pool-level adjustments when we see very high IO loan concentrations or when an IO loan bucket that has no discernible difference in LTV (i.e., it is not "pre-amortized"). The average LTV for the full-term IO loans issued in the first quarter was 87%, about 300 bps below the overall average.

Effective loan counts, or Herfindahl-Hirschman Index scores, which measure concentration or diversification by loan size, remained stable at just under 28. We consider this level to be well diversified, meaning that additional increases in the measure would result in only small marginal benefits to credit enhancement. The average deal size grew by about $120 million to $1,075 million in the first quarter, while the average number of loans bumped up slightly to 50 from 49.

Marked Differences In LTV By Loan Size

Investors have noted that the increase in pari passu portions of larger loans within conduit pools may have caused credit metrics to be somewhat "barbelled" when comparing the top 5 or 10 loans to the remainder of the pool. To test this assertion, we analyzed the conduits we rated in 2019, bucketed the top 20 into groups of five (along with a fifth bucket of all loans outside of the top 20), and compared their weighted average S&P Global Ratings LTV (see chart 1).

Chart 1

The data show that the top 5 largest loans have, on average, considerably lower S&P Global Ratings LTV ratios than the remainder of the pool. The top 5 largest loans have LTV ratios of 88%, compared with 92% for loans 6-10, 96% for loans 11-15 and 16-20, and 93% for loans 20 and up.

To address potential credit barbelling in conduit collateral pools, we designed our credit model to apply diversity benefit at the loan level instead of at the transaction level. Loans with stronger credit characteristics (i.e., high DSC and low LTV) receive more diversity benefit than weaker loans, and very weak loans receive zero diversity benefit. In other words, regardless of a pool's Herfindahl-Hirschman Index score, increased barbelling will result in increased S&P Global Ratings credit enhancement levels.

Lodging And Retail Exposures Increased

Lodging exposure bounced back to 14% in the first quarter, after declining to 8% in fourth-quarter 2020--well below the quarterly range of 12%-17% since the beginning of 2013. Recent weekly revenue per available room (RevPAR) figures for U.S. lodging properties have dropped 80% year-over-year nationally, according to data from STR, though showing considerable variation by chain segment.

Retail exposure also bounced back a bit, to 21%, in the first quarter after declining to a record CMBS 2.0 low of 18% in fourth-quarter 2020. Retail sector performance is somewhat mixed due to the COVID-19 containment measures, with online channels active and foot traffic at most physical locations declining.

Meanwhile, multifamily exposure fell four percentage points to 18% (though still higher compared to recent vintages), and offices and industrial were steady at 30% and 5%, respectively.

Chart 2

Cloudy Credit Outlook And Lower Issuance Forecasts

The CMBS new issuance market remains closed for business, after ceasing activity in mid-March. While the Fed's Term Asset-Backed Loan Facility (TALF) allows for the financing of outstanding 'AAA'-rated conduit securities, it excludes collateral issued on or after March 23. When will the market reopen is anyone's guess at this point and depends on a variety of factors, including the level of primary and secondary market spreads, the magnitude of the credit impact of COVID-19 on lenders, borrowers, and servicers, and the recovery prospects.

Our economic team currently forecasts a sharp decline in U.S. GDP and a sharp increase in unemployment in the second quarter, with some recovery in the second half of 2020. As a result, we expect heightened stress on lodging, retail, and multifamily borrowers as the year progresses. Over the next 12 months, we expect stable to negative outlook and rating trends in U.S. CMBS, with risks remaining biased to the downside.

Related Criteria

• CMBS Global Property Evaluation Methodology, Sept. 5, 2012
• Rating Methodology And Assumptions For U.S. And Canadian CMBS, Sept. 5, 2012

Related Research

• U.S. CMBS Conduit Update Q3 2019: Debt Service Coverages On The Rise, Oct. 9, 2019
• When The Cycle Turns: How Would Global Structured Finance Fare In A Downturn, Sept. 4, 2019
• U.S. CMBS Conduit Update Q2 2019: 'BBB-' Levels Remain Too Low, July 10, 2019
• U.S. CMBS Conduit Update Q1 2019: Loan Metrics Improve As Steady Conditions Prevail, April 4, 2019
• U.S. CMBS Conduit Update Q4 2018: Metrics Deteriorated A Bit, Stable Ratings Expected In 2019 With Some Caveats, Jan. 9, 2019
• U.S. CMBS Conduit Update Q3 2018: Metrics Mostly Improve Although Deal Dispersion Widens Again, Oct. 4, 2018
• U.S. CMBS Conduit Update Q2 2018: Credit Quality Variances Are On The Rise As Loan Structural Features Weaken, July 5, 2018
• U.S. CMBS Conduit Update Q1 2018: Interest-Only Loan Volume And LTVs Remain High, April 2, 2018