CRE CLO Issuance This Year Will Be Well Below Market Consensus

Commercial real estate collateralized loan obligations (CRE CLOs) do not “portend a year-end celebration,” writes Morningstar DBRS. Anyone hoping for a lift at the end of the year will find the elevator heading down.

Results in Q3 may have provided a false hope. But the “modest spike in volume” could have been the results of several quarters of originations by issuers. In that case, the improvement was using up inventory, and the issuers will need time to pull together enough loans to provide the collateral for a bond transaction.

Total volume for 2023 “is likely to be less than $10.0 billion and well below the market consensus at the beginning of the year, which expected a strong pickup in H2 2023,” the company wrote. “The pickup never materialized, the broader U.S. economy proved to be resilient, and for the time being, higher interest rates have not caused a material slowdown in economic activity. However, the commercial real estate sector has been less fortunate; the high interest rates have caused significant disruptions and a slowdown in property sales and new loan originations.”

There were four CLO transactions last quarter — two static and two managed. “Multifamily properties continue to represent most of the collateral in transactions at 63.6% of all loans contributed into CRE CLOs, though it declined from 80.5% in Q3 2022. In Q3 2023, office loans saw a sharp increase at 7.9% from none in the previous two quarters of 2023 and 3.7% in the same quarter last year,” they wrote.

Looking at changing percentage mixes is difficult because of the significant changes in volume. Too many factors are in movement simultaneously to firmly grasp the dynamics. The office loan increase is interesting, but hard to put into a greater context. There is some good news in that happening at all, but this may also be a case of multiple quarters of work finally coming together without necessarily leaving enough progress to repeat the performance in the current quarter. It will take more observation in hindsight to see what the trend has been.

The Q3 delinquency rate increased by 1 basis point from Q2, which is essentially flat. However, special servicing was up 150 basis points from the end of Q2 in 2023 and up 194 basis points from the end of Q3 in 2022.

“As of the Q3 2023 reporting, the overall loan modification rate for CRE CLOs decreased slightly to 11.34%, down 52 bps from 11.86% in June 2023,” they wrote, pointing out that Q3 was the first recent time when the quarter-over-quarter modification rate declined rather than increased. Again, that may be good news, or it could be a quirk where the number of loans that might need modification has dropped for some other reason.