Refinancing Woes Threaten To Raise Delinquencies, Higher Rates Prompted Shorter Terms, Bondholders Put on Hold

Jan 11, 2024

Refinancing Woes Threaten To Raise Delinquencies: Fitch Ratings expects U.S. commercial real estate loan refinancing prospects to materially deteriorate in 2024 relative to 2023, leading to higher commercial mortgage-backed securities delinquency rates across all major property sectors. “We are projecting the overall U.S. CMBS delinquency rate will increase to 4.5% in 2024 and to 4.9% in 2025 from 2.25% as of November 2023, due to more maturity defaults from higher interest rates, tighter access to capital, fewer special servicing resolutions, less new issuance and increased loan modifications,” Fitch analysts reported. The office delinquency rate is projected to more than double and surpass its historical peak in 2025 as the continuation of hybrid work policies and space cutbacks negatively affects property valuations and performance. Retail and hotel loan delinquency rates are projected to rise significantly as softness in consumer spending and declines in leisure travel create refinancing difficulties for the larger volume of loans due over the next two years. However, rates are expected to decline slightly in 2025 as the macroeconomy stabilizes and interest rates fall. The delinquency rate for loans backing multifamily properties is expected to double in 2024, exceeding its pandemic peak, given heightened levels of new supply, slowing revenue growth and higher expenses affecting property net cash flow. More than $31.2 billion, or 1,473 CMBS loans, are scheduled to mature in 2024, and $37.9 billion, or 2,437 loans, mature in 2025. These annual totals are higher than the $26.5 billion that matured between October 2022 and December 2023. “While overall refinancing activity in 2023 was better than anticipated, refinancing rates for office, multifamily and industrial progressively declined in the last six months, indicating mounting challenges,” Fitch reported. Fitch estimates that just 46% to 48% of 2024 maturities would be able to refinance compared with a rate of 73% for loans maturing between October 2022 and December 2023. Both the office and retail sectors show sub-40% refinance rates for 2024. New equity from the borrower, ranging from 25% to 33% of existing debt, would be necessary to pass those refinancing thresholds. Refinancing rates would improve in 2025 to 51%-75%, driven by lower interest rates and stabilizing macroeconomic conditions, the rating agency said. Higher Interest Rates Prompt Shorter-Term Loans: In 2023, the commercial real estate securitization market offered five-year fixed-rate loans to borrowers hesitant to lock in longer-term 10-year loans. This led to the market’s first multi-borrower CMBS deal issuance solely consisting of five-year loans. Ten transactions followed, bringing the total five-year issuance to $8.8 billion. That represented 45% of the year’s multi-borrower issuance, according to bond rating firm KBRA. Based on KBRA’s current visibility, there are already two five-year deals queuing up for this month, and it expects more will follow as the year unfolds. Bondholders Put on Hold: As 2023 ended, the CMBS market saw an unusual servicer action. Wells Fargo Bank, the master servicer of CMBS deal JPMCC 2013-C16, declared the principal and interest advance amounts for all five remaining loans in the pool — loans totaling $101 million — as nonrecoverable. In a CMBS loan, the servicer advances the principal and interest that would have been due to bondholders so that they receive what they expected. Wells Fargo’s action immediately cut off those December interest payments to bondholders of the deal. “The sweeping fresh non-recoverability determinations in JPMCC 2013-C16 illustrate how a once obscure master servicer decision is now quickly turning into a critical driver of seasoned deals’ performance and valuation,” wrote Stav Gaon, head of securitized products research and strategy at Academy Securities, in an analysis of the action. “The servicer's rationale for triggering such widespread nonrecoverability underscores that servicers are shifting to make determinations based on deal-level parameters, rather than mostly as a function of individual loan situations.” The action signals that more 10-year-old CMBS deals could see master servicers take similar action affecting monthly interest payments or that future monthly payments could be stalled, he added. There is a potential upside for bondholders, according to Gaon. Bondholders could stand to see more funds returned once the loan or property liquidations eventually happen.

By Mark Heschmeyer, CoStar News

Summary:

Fitch Ratings anticipates a significant deterioration in the prospects for U.S. commercial real estate loan refinancing in 2024, leading to an increase in commercial mortgage-backed securities (CMBS) delinquency rates across major property sectors. The overall U.S. CMBS delinquency rate is projected to rise from 2.25% in November 2023 to 4.5% in 2024 and 4.9% in 2025, driven by factors such as maturity defaults, higher interest rates, tighter access to capital, and fewer special servicing resolutions. The office delinquency rate is expected to more than double by 2025 due to hybrid work policies, while retail, hotel, and multifamily loan delinquency rates are also forecasted to increase. Additionally, higher interest rates in 2023 led to a trend of shorter-term, five-year fixed-rate loans in the commercial real estate securitization market. Furthermore, Wells Fargo’s recent non-recoverability determinations for CMBS deal JPMCC 2013-C16 highlight a potential shift in servicer decisions based on deal-level parameters, impacting interest payments for bondholders but potentially offering a future upside through property liquidations.