The CRE CLO Problem Is More Grim Than It Seemed
While not the most common form of CRE financing, this backing of riskier projects could be the start of a default wave.
Last month, GlobeSt.com reported on Arbor Realty Trust’s non-performing loans, an event that had made CRED iQ sit up and consider CRE collateralized loan obligations, or CLOs.
CRED iQ typically doesn’t consider CRE CLO deals from its regular delinquency reports. But it decided to take a “deep dive” into CRE CLOs to understand what might be happening with other CRE CLO issuers. The answer in short: “Arbor is not alone.”
There were $80 billion in CRE CLO loans. The “vast majority” used floating-rate loans with three-year terms. There were also optional term extensions, depending on qualifying financial conditions. Since 2019, big issuers included MF1, Arbor, LoanCore, Benefit Street Partners, Bridge Investment Group, FS Rialto, and TPG.
CRE CLO distress rates jumped from 1.4% in January 2023 to 7.4% in December, and then another leap to 8.6% in January 2024, which they said was a 440% increase over 12 months in distress levels. CRE CLOs under distress jumped from $1.3 billion in February 2023 to more than $6.8 billion in January 2024.
These are “primarily stuffed full of short-term, floating-rate loans for properties undergoing renovations or expansions, the type of risky debt that banks or CMBS often don’t want to hold,” Bloomberg wrote this week, considering the developing story. Short sellers are targeting publicly-traded issuers facing so many missed payments that there may be little equity value.
Now, admittedly, $80 billion in the face of a $20 trillion CRE market is tiny. But the CRE CLO market is clearly facing stress. As Bloomberg said, the instruments are often heavily weighted by short-term, floating-rate loans for renovations or expansions.
“The CRE CLO market is the first shoe to drop in terms of defaults in the CRE debt markets,” Mark Neely, director of alternative investments at GenTrust, a money manager, told Bloomberg. “The loans inside CRE CLOs tend to be for transitional properties, so the borrowers are counting on reselling them before the loan matures. But today many borrowers can’t sell properties for anywhere near where they bought them.”
Because of the transitional nature of CRE CLO-backed projects, any shakeup could interrupt extended chains of business, potentially affecting a broader swath of business that could undermine the entire CRE market.