Overall Delinquency Remains Stable While Office Sector Climbs

As of the end of March 2023, the overall delinquency (DQ) rate for U.S. commercial mortgage-backed securities (CMBS) transactions was 2.7%, and though relatively stable over the past few quarters, it is up from its post- COVID-19 pandemic low of 2.5%. That said, the rate has generally declined since peaking around 9.0% 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) remains high, at about 86.0%. The lodging and retail sectors still maintain the highest 30-plus-day delinquency rates, at 3.8% and 6.0%, respectively, although they have been improving since peaking above 20.0% and 15.0%, respectively. The office sector rate is now 2.7% and has risen about 110 basis points (bps) during the past three months. Multifamily and industrial round out the major property types with 1.4% and 0.4% rates, respectively.

The special servicing rate has ticked up by approximately 40 bps during the last quarter, to 4.8% in March. The rate for office stands at 4.5% and is up nearly a full percentage point since year-end 2022.

Property Types In Focus

The uncertainty about future demand for office/hybrid work space and the potential impact on fundamentals (vacancy/rents) and valuations is the key property type risk facing the U.S. CMBS sector right now, and likely will remain so for the next couple of years. The prospect of a recession, and a sharp movement upward in interest rates/capitalization rates makes the picture that much murkier, along with the resultant dip in transactions reducing price discovery (not to mention that commercial real estate (CRE) is historically a cyclical asset class). Last autumn, S&P Global Ratings published a scenario analysis for conduits with specific regard to office loan exposure, (see "Scenario Analysis: Exploring The Potential Impact Of Office Value Declines Beyond The Base Case In U.S. Conduit CMBS," published Oct.20, 2022), which presented the approximately 40.0%-50.0% hypothetical market value declines for class A and B properties, with more stress on the latter. Our conclusion was that super senior U.S. conduit CMBS classes, on average, appear relatively insulated to our stresses, with more potential downward rating movement present in 'A' and 'BBB' rated classes in our more severe scenarios. On the U.S. single-asset single borrower (SASB) CMBS side, we have seen outcomes vary widely with regard to recent rating actions on deals backed by office loans/properties. These have ranged from affirmations across all rated classes within a deal, to a few cases of 'AAA' downgrades. Our stance to date is that performance, and thus rating outcomes, may continue to vary at the building, location (urban/suburban) and market level, depending on tenant/industry mix, rollover risk, office utilization (struggling in major coastal markets, but better elsewhere), land values, and other factors. That said, the entire stock will face declines from rising rates and risk premia, regardless of property-level cash flow. According to the latest Commercial Property Price Indices (CPPI) from Green Street, overall office property values have declined approximately 25.0% over the past year.

Multifamily properties have also experienced some deterioration in valuations over the past year, at -21.0%, according to Green Street. While different from the office property scenario in many ways, this shows the impact of the sharp increase in benchmark interest rates and capitalization rates. Given that the single-family housing market remains undersupplied, and that only modest-to-moderate drops in home prices are currently expected (after a strong run-up in 2022), we don't foresee the same level of stress facing multifamily properties as we do with office properties. That said, properties underwritten with little margin for error will face heightened refinancing risk, and even some more term risk if we see a worse-than-expected recession with higher unemployment; our current U.S. economic base case remains a mild, and somewhat short recession, with unemployment peaking in the 5.0% range in early 2025.

Retail properties have broadly improved along with consumer spending since the COVID-19 pandemic, especially with regard to cash flow metrics, and as mentioned before, delinquencies. That said, many regional malls still face an uncertain future, and thus an uncertain financing environment. This has led to numerous rating actions over the past 12 months, including a handful of U.S SASB CMBS 'AAA' classes.

Lodging revenue per available room (RevPAR) has firmly rebounded, and rating actions have been limited over the past six-to-nine months. While a recession may have some limited idiosyncratic impact, the base case outlook from our corporate lodging analysts is a flat-to-5.0% increase in U.S. RevPAR for 2023, which should buoy the sector.

Refinancing Risk Emerging

With 6.0%-8.0% coupons replacing the 3.0%-5.0% coupons of recent years, and tighter lending conditions expected, naturally the specter of refinancing risk is rising. On the plus side, many market watchers think that benchmark rates will come down from current levels somewhat over the next few years, but the details matter. If the expectation stays in the 18-24 month range for a "pivot" downward, loan extensions could mitigate some performance deterioration, as we saw last cycle. Rates that remain higher for longer would naturally introduce more pressure to the system, and could have borrowers throwing in the towel at a higher frequency, as opposed to infusing equity, especially in more economically stressed property types.

Chart 1

In the chart above, we show our exposure to rated conduit loans coming due in the remainder of 2023 and 2024 by property type. Note that this includes non-defeased, currently performing collateral, with a debt service coverage (DSC) over 1.00x. Office loans make up about 35.0% of the total over the period, with retail next at 27.0%, and multifamily at 15.0%.

New Issuance Has Fallen; And SASB With It

There was only about $6 billion in first-quarter 2023 private-label CMBS issuance, excluding commercial real estate collateralized loan obligations (CRE CLOs; $1 billion). Long-term interest rates have fallen recently, but CMBS spreads have widened, which may keep issuance subdued for the time being.

Indeed, along with the market as a whole, single-borrower CMBS issuance has fallen off, with just five transactions totaling approximately $4 billion in fourth-quarter 2022, and six deals totaling just under $3 billion in first-quarter 2023. We compared this to approximately $19 billion priced across 26 transactions in the first quarter of 2022.

The property-type exposure for SASBs continues to evolve coming out of the pandemic. Industrial and lodging have become more prominent in the limited sample sizes of recent quarters, with a smattering of retail, self-storage, and office sectors making up the rest.

Chart 2

Of the five deals priced in the fourth quarter of 2022, we rated two and provided preliminary feedback on three. Of the six deals priced in first-quarter 2023, we reviewed five and rated two.

Table 1

Elevated SASB leverage in recent vintages has been a concern for us, although the levels have come down in the limited sample sizes of the most recent quarters. When we decline to provide preliminary feedback on a deal (one instance in the first quarter of 2023, two in the fourth quarter of 2022), it is generally due to high leverage.

During the past two quarters, we've rated two deals backed by hotel portfolios (WMRK 2022-WMRK and LAQ 2023-LAQ), a self-storage transaction (GSMS 2022-AGSS), and one trade backed by a 42-property portfolio comprising mostly retail and industrial assets (OAKST 2022-NLP).

A Small Sample Size For Conduits

Challenges in collateral aggregation have been hampering conduit issuance for some time, and first-quarter 2023 was no exception. Nevertheless, here are a few observations:

• Overall loan-to-values (LTVs) have been lower compared with recent history and were down 230 bps to 84.0% in the latest quarter.
• DSC ratios have been falling along with the higher interest rates, off 0.17x in the most recent reading, to 1.54x. Interest-only percentages have remained high.
• Deals have become smaller and more concentrated. The top 10 percentages averaged 51.0% in 2021, 55.0% in 2022, and was closer to 62.0% in the first four deals of 2023.

Of the four conduit transactions that priced in first-quarter 2023, we rated one (see table 2). The four offerings had an average of 37 loans, and an average deal size of $820 million.

Table 2

Property Type Exposures Continue To Shift Within Conduits

We continue to see some movement in property-type compositions from quarter to quarter.

Industrial properties, which have been one of the star performers of recent years, have increased to a record 18.0% in first-quarter 2023. The office sector has rebounded to 28.0%, from 21.0% in fourth-quarter 2022, which is down from an average of 38.0% in full-year 2022. Apartment, lodging, and retail sectors saw little change quarter-over-quarter, although the multifamily property segment is off seven percentage points, lodging is up about six percentage points, and retail is up about 13 points year-over-year. This likely reflects, at least in part, the discussion of recent property type trends in the earlier part of this report.

Chart 3

Related Criteria

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