CMBS, CRE CLO Transactions Pass Their First Stress Test

Rating agency KBRA just came out with a look at securitization credit performance in commercial real estate in the wake of the pandemic. The news/? “CRE securitization credit performance among conduit, single borrower/large loan (SB/LL), and CRE collateralized loan obligation (CLO) transactions has held up reasonably well,” the report noted. “That is not to say that there were no major challenges along the way, but lessons learned from the GFC [global financial crisis] helped to mitigate the credit impact of COVID.”

Not letting the perfect become the enemy of the good, the ability of changes since the GFC to manage challenges is terrific news. A major trigger of the global financial crisis was securitization. Complex derivative vehicles that were supposed to free capital for investment became ticking financial bombs.

Even before the dust finally settled—that took at least ten years and still not everyone fully recovered—major changes in regulations and business practices reset how financing would happen. As KBRA suggests, the alterations to reduce risk seem to have worked.

Between February 2020 and June of the same year, CMBS delinquency rates went from 1.2% to 8.2%, with, as one might expect, lodging and retail suffering most because of restricted movement and mandated business shutdowns. The two sectors fell to 11.4% and 6% respectively. As of February 2022, KBRA measured the overall delinquency rates at 3.3%, although lodging and retail remained relatively elevated at 7.1% and 5.4%, given cash flow problems.

“Comparatively, in the aftermath of the GFC in 2008, delinquencies took much longer to peak (this was in August 2012), as well as decline, bottoming out in March 2016,” the firm wrote.

With reduced delinquency rates came a revitalization of the CMBS market, again gaining the volume it had before the GFC. “Why is the CMBS market having so much success/?” Gerard Sansofti, an executive managing director as well as debt and loan sales platform leader at JLL, told GlobeSt.com in February 2022. “When a money market manager sees I can get more on a AAA mortgage bond than a AAA corporate bond, I’m going to invest in the mortgage bond.” He added that whereas CMBS used to be more than 50% of CRE financing before the GFC, it’s between 10% to 15% now, and so far less of a risk.

CLOs have been making a comeback since last year, according to experts. “With CLOs, commercial real estate borrowers can get a cheaper rate because it can be laid off to the investors,” Brett Forman, eastern US executive managing director for private lender Trez Capital, told GlobeSt.com in May 2021.

“KBRA has rated 454 CRE CLO securities across 64 transactions, none of which has experienced rating downgrades,” the firm noted. “This reflects the structural features of the deals and performance of the underlying collateral, which has contributed to a low KBRA CRE CLO delinquency rate, 1% as of February 2022.”