If CMBS Defaults Keep Rising, Interest Rates on New Deals Could Jump
The financing mechanism is important as banks pull back from CRE and many property owners need options.
Commercial mortgage-backed securities are particularly important for CRE these days. Bad news about defaults could mean that already high interest rates could start to increase even more.
Many banks have pulled back from lending. They’ve been concerned over asset valuations and the potential that nervous depositors might pull their money. That could lead to potential solvency questions, as happened to some high-profile banks in 2023.
Simultaneously, many properties that had been purchased in 2021 and 2022, with market-inflated prices, low interest rates, and high leverage are coming up for refinancing. Frequently, higher-rate financing alternatives like CMBS were the only practically available choices.
High spreads over base interest rates, whether a 10-year Treasury or secured overnight finance rate between banks (SOFR), are a lender’s reaction to expected risk. Whether only late payments or possibly even default, there’s a cost. Higher interest across everyone applying for a loan pays the freight.
Default rates have been going up, according to Trepp. Overall CMBS delinquency has gone from 3.12% a year ago to 4.25% six months ago, 4.58% three months ago, 4.51% in December 2023, 4.66% for January 2024, and 4.71% in February 2024.
About 94.31% are current; 0.30% are 30 days delinquent; 0.11% are 60 days delinquent; and 0.56% are 90 days overdue, with 1.22% in foreclosure and 0.87% real estate owned (REO), so officially foreclosed. Include the loans beyond maturity date but current on interest, delinquency would leap to 5.69%.
The changes aren’t evenly divided across product types. At 6.63%, office has the highest delinquency rate of 30 days or more. Retail is second at 6.03%. Lodging comes in third at 5.45%. Multifamily is 1.81% and industrial, 0.43%.
David Rosenberg, president of Rosenberg Research, said in a note last week that CMBS bonds should be an even bigger concern than commercial bank exposure to their CRE loan portfolios, according to a Business Insider report.
“While equity investors get sucked into the AI mania, there are real signs of stress in the economy, and this is just one of them,” Rosenberg wrote. “When everything looks perfect, it takes one event to burst the bubble, and multiple data points highlight that this is where the next contagion may be brewing.”
He said that CMBS is a serious problem because investors are exposed to falling valuations and increasingly bad loan performance.