The COVID-19 Pandemic's Evolving Impact

This is S&P Global Ratings' eighth quarterly update on U.S. commercial mortgage-backed securities (CMBS) transactions published in the midst of the COVID-19 pandemic.

As of the end of March, the overall delinquency (DQ) rate for U.S. commercial mortgage-backed securities (CMBS) transactions was 2.9% and has steadily declined since peaking around 9% in Summer 2020. Although the overall DQ rate has declined, the share of delinquent loans that are 60-plus-days delinquent (i.e., seriously delinquent) is high, at about 93%. A substantial majority of the total population of arrears remains in the lodging and retail sectors; the 30-plus-day DQ rate for retail and lodging is in the 6%-7% range, while office is between 1-2%, and industrial and multifamily are below 1%. We believe office will be a sector to watch in 2022 as return-to-office plans emerge throughout the year amid a backdrop of growing vacancy rates and transaction-specific stresses. Of note, see our recent rating actions on two Manhattan office SASBs: 1740 Broadway ("BWAY 2015-1740 Mortgage Trust Ratings Lowered On Seven Classes; One Affirmed," published April 1, 2022) and 350 Park Ave. ("One Rating Lowered, Five Affirmed From VNDO Trust 2016-350P," published April 5, 2022).

SASBs Continue To Lead Issuance

Single-asset single-borrower (SASB) transactions continued their trend of driving private-label CMBS issuance in the first quarter, accounting for two-thirds of volume. Though SASB's share of issuance had been growing in the years leading up to the pandemic, its dominance has remained. However, the prospect of higher interest rates might serve as a headwind, or at the very least see the current ratio of floating- vs. fixed-rate issuance (81%/19%) start to rebalance as borrowers attempt to lock-in rates. Longer-term, higher-borrowing costs may also start to elevate refinance risk, especially if interest-only (IO) loans became less prevalent.

The property type exposure for SASBs continued to also evolve during the pandemic. In the first quarter of 2021, SASB issuance volume was around $9.2 billion and was dominated by office (59.4%) and to a lesser degree, industrial (24.9%). The remainder was primarily a mix of mostly multifamily and retail asset types.

Chart 1

By the first quarter of 2022, which saw twice as much issuance compared to the prior first quarter ($18.4 billion), industrial/self-storage supplanted office as the most common asset types, accounting for 53.2% of issuance. Multifamily SASBs continued to grow as a share, and lodging SASBs started to emerge after being dormant. In total, 26 SASB transactions priced in the first quarter; we rated five and provided preliminary feedback on 20. In the fourth quarter of 2021, issuance was at a record-setting level of $33.1 billion across 39 transactions; we rated 12 of these and provided preliminary feedback on 22 (see table 1).

Table 1

Excessive SASB leverage continues to be a concern for us as evidenced by our first-quarter 2022 loan-to-value (LTV) ratio of 128.7%. In fact, our fourth-quarter 2021 LTV of 116.4% would be considerably higher if it were not for the 17 transactions we declined to provide preliminary feedback on, often due to excessive leverage. We believe increased leverage is more a reflection of growing debt levels as opposed to our valuation opinions, which have remained more constant as reflected by our relatively range-bound value variances. (Table 2 provides a summary of deals we reviewed in first-quarter 2022 by property type.)

Table 2

While the share of office SASBs was down considerably compared to a year ago, by count, office and industrial were the most common SASBs to come to market. However, unlike office, which had a relatively lower S&P Global Ratings' LTV (123.8%), our LTVs for multifamily, self-storage, and industrial were higher at just north of 130%. While we concede these asset types have exhibited strong fundamentals in terms of supply/demand dynamics, including rising rents, we remain concerned with relying too much on future rent growth expectations to de-lever transactions, especially with the current rising rate environment.

Mixed Metrics For Conduits In First-Quarter 2022

The loan metrics for conduit new issuance transactions showed a mixed bag on a quarter-over-quarter basis in first-quarter 2022. These included the following:

• Overall loan-to-value fell by two percentage points quarter over quarter (q/q) to 96.5%. There was a wide dispersion in deals we rated and those we didn't: the average LTV for the five S&P Global Ratings-rated transactions was 88.9%, and the average of the four we didn't rate was 101.0%.
• Debt service coverage (DSC) ratios were more or less flat at 2.36x and remain at a very high level. We note that (still) historically low interest rates and high IO loan percentages are clearly contributing to elevated DSC ratios. That said, the 10-year U.S. Treasury yield has increased sharply of late and is up over 100 basis points (bps) since year end.
• Combined IO percentages remained high, at near 90%, and the full-term IO percentage set a new post-Great Financial Crisis (GFC) quarterly record, at 78.5% of pools.
• Our average cash flow and value variance to issuer values both decreased from last quarter's highs and are more in line with Q1-Q3 2021 readings.
• Effective loan counts (as measured by the Herfindahl-Hirschman Index score) were steady, although actual loan counts have decreased during the last two quarters. The average deal size was up over $100 million q/q, standing at about $1.1 billion.

Our 'BBB-' Credit Enhancement Levels Remain Well Above The Market Average

Our 'AAA' credit enhancement level was about 250 bps above the actual level, on average, while our 'BBB-' credit enhancement level was 480 bps higher. We continue to believe these 'BBB-' rated classes could prove relatively more vulnerable to event risk--especially with more concentrated pools. As a result, we have not rated many of these classes in recent vintages.

Of the nine conduit transactions that priced in first-quarter 2022, we rated five (see table 3). The nine offerings had an average of 53 loans, with top 10 loan concentrations rising 110 bps q/q to 53.1%.

Table 3

The conduit deals priced during first-quarter 2022 had lower LTV ratios and slightly higher DSCs on a quarterly basis. The average LTV was 96.5%, a 200 bps decrease q/q. The dispersion between the average LTV within the five deals S&P Global Ratings rated to the four that we didn't was quite wide, 88.9% compared to 101.0%.

Average DSC rose 0.01x to 2.36x in the first quarter, maintaining an elevated level. This likely reflects two factors: low interest rates and a lot of full-term IO loans. For the purposes of our DSC analysis regarding partial IO periods, we utilize the figure after the IO period ends; but partial IO percentages remain somewhat low. We also note that the 10-year U.S. Treasury yield has risen quite a bit of late and may begin to exert some downward pressure on coverage during the next few quarters, should the higher levels persist (or increase further).

IO as an overall percentage of the collateral pools rose to about 89.5% in first quarter 2022 from 87.8% in fourth-quarter 2021. Full-term IO loans made up 78.5% of the collateral pools, a new "2.0" (post-GFC) quarterly record.

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 has no discernible difference in LTV versus the average (i.e., it is not "pre-amortized"). The average S&P Global Ratings' LTV for full-term IO loans issued in first-quarter 2022 was 95.0%, about 150 bps below the overall average.

Effective loan counts, or Herfindahl-Hirschman Index scores, which measure concentration or diversification by loan size, remained flat at 26.4. We consider this level to be relatively well-diversified. The average deal size rose $116 million to $1,102 million in first-quarter 2022, while the average number of loans fell to 53 from 61 in the previous quarter.

Property Type Exposures Continue To Shift Within Conduits

We continue to see quite a bit of movement in property type from quarter to quarter.

Industrial exposure fell back to 8% from 10% last quarter, still modestly above the 6%-7% range in recent pre-pandemic (namely 2018 and 2019) vintages. The property type continues to post impressive year-over-year (y/y) appreciation figures (up 41% y/y per Green Street Advisors' March 4, 2022, report), and accounted for a large percentage of the quarter's SASB transactions.

Retail exposure was 18% in the first quarter, down from 24% in the fourth quarter, and still well above the 8%-9% lows set in mid-2020. While we are seeing improvement in foot traffic and valuations more broadly, we continue to see secondary and tertiary market-located class B and C malls struggle.

Lodging rose to 5% from 1% last quarter. Revenue per available room (RevPAR) is not expected to recover to 2019 levels until 2023. While leisure travel rebounded significantly in 2021, corporate demand and meeting and group demand levels remain depressed; they will likely recover as the omicron variant fades.

Despite all the headlines about the future of office-dwelling employees, the property type remains the top exposure, at 43% for the first quarter, up 13 bps q/q! There remains a considerable amount of uncertainty for the sector in the medium term, as many returns to office were delayed by the rapidly spreading omicron variant. Values remain down about 4% vs. pre-COVID-19 prints, according to Green Street Advisors.

Meanwhile, multifamily exposure fell three percentage points to 15%. Of the five major property types, multifamily has the second-lowest delinquency rate (industrial: 0.3%), at just 0.7% as of March 2022.

Chart 2

Issuance Steady Amid Headwinds; Forecast Revised Downwards To $90 Billion

There was about $29 billion in first-quarter 2022 private-label CMBS issuance, excluding commercial real estate collateralized loan obligations (CLOs), nearly doubling the $15 billion from the same period one year ago. The breakdown between SASB and conduit in first-quarter 2022 was roughly two thirds/one third, or over $18 billion SASB, $10 billion conduit, and a couple of other deals. Though it was a record-setting first quarter, our January forecast of $110 billion warrants being revised down to $90 billion given prevailing headwinds, including a pretty sharp rise in long-term interest rates in the last month or so in response to historic levels of inflation, paired with the widening of credit spreads across structured finance stemming largely from the Russia/Ukraine conflict.

Related Criteria

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