Commercial mortgage delinquencies returning to prerecession levels

The delinquency rates of most types of commercial and multifamily mortgages fell in the third quarter, with multifamily loan delinquency rates back at prerecession levels, according to Mortgage Bankers Association (MBA) research.

The 30-day delinquency rate for commercial mortgage-backed securities (CMBS) loans was down 0.37 percentage points to 5.47%. The 60-day delinquency rate of commercial and multifamily loans held by life insurance companies fell 0.03 percentage points to 0.05%.

The 60-day delinquency rate for multifamily loans backed by Fannie Mae decreased to 0.09%, while the 60-day rate for Freddie Mac multifamily loans increased 0.01 percentage points to 0.03%.

The post-recession highs for Fannie Mae and Freddie Mac multifamily delinquency rates occurred around 2010. In the fourth quarter of 2010, the 60-plus day delinquency rate for Fannie Mae was 0.71%, and was 0.33% in the third quarter of 2011 for Freddie Mac.

In the fourth quarter of 2006, the Fannie Mae 60-day delinquency rate was 0.08%, and the Freddie Mac rate was 0.05%.

Some delinquency rates were still above recession-era peaks. Approximately 1.28% of loans held by the Federal Deposit Insurance Corp. and banks were delinquent 90 or more days in the third quarter. That delinquency rate peaked between 2010 and 2011 at above 4%, with the low at 0.8% around mid-2006.

CMBS 30-plus and real estate owned (REO) delinquency rates stood at just above 5% in the third quarter. The peak was in 2011 at close to 9%. Between 1997 and 2009, CMBS delinquencies were below 2%.

“Improving property fundamentals and values, as well as a strong finance market, are helping drive delinquency rates down across all investor groups,” said MBA Vice President of Commercial Real Estate Research Jamie Woodwell in a press release.

Risk Rule Seen Favoring Larger B-Piece Buyers

As the commercial MBS industry prepares for the risk-retention rules due to take effect in about two years, B-piece buyers face the prospect of raising more capital, from a broader range of sources, in order to stay in the game. The result, industry experts say, could be a different roster of players — likely fewer, larger firms, including new entities formed by combinations of high-yield and investment-grade bond buyers. “I think you’re going to see a lot of innovative structures,” said George Green, associate vice president of the Mortgage Bankers Association.

The reason is CMBS issuers are expected to rely on B-piece buyers to assume the risk-retention responsibility, and that will mean buying more bonds, farther up the capital stack, than those investors are accustomed to taking.

“[The rule] is going to benefit larger, more diversified investment managers,” said Stephen Renna, chief executive of the CRE Finance Council. “If you’re smaller, and your source of capital is more specific, it could be more difficult to participate in deals.”

At the heart of the voluminous final rules, adopted last month by six federal regulators to implement provisions of the Dodd-Frank Act, is the requirement that securitization issuers retain 5% of each deal. An exception for CMBS allows the issuer to instead sell bonds equivalent to 5% of the deal proceeds, from the bottom of the capital stack, to one or two “third-party purchasers.”

Whereas B-piece buyers now take the below-investment-grade portion of CMBS deals, that won’t be enough to satisfy the 5% rule. Industry pros say issuers will have to carve off a chunk of triple-B-minus bonds — maybe even some single-As — and wrap them into an expanded B-piece. The regulators rejected proposals to allow two investors to split that bottom piece into senior and junior portions. If there are two buyers, they must take pari-passu portions.

The resulting B-pieces won’t match the yield hurdle or the buying power of many current buyers. One source gave a back-of-the-envelope calculation that, where it might take $40 million to acquire a typical B-piece today, it could cost $60 million to buy enough bonds to satisfy the 5% risk-retention requirement.

“You have to get better-capitalized B-piece buyers,” said an executive at a major asset manager. “They need to be bigger so they can buy more.” And they’ll have to be willing to add investment-grade bonds to their usual diet of high-yield paper. That necessity is likely to lead to the invention of vehicles that bring together investors with varying risk appetites.

One of the main ideas being floated by industry experts would involve a B-piece buyer raising capital from a wide range of investors for a fund that would be structured with varying levels of risk for specific limited partners. As one current buyer described that scenario: “I can bring in another investor within the fund framework and create a return structure that works for him and also works for me. Maybe the fund would have a Class A for the senior risk and a Class B for the junior risk. I don’t think that would run afoul of the regulations.”

A slightly different approach would be for two or more parties to form a joint venture to buy B-pieces and split up the risks and rewards — including control of the special servicer — tied to specific senior and junior bonds. Securitization lawyers said such a joint venture could qualify so long as it was a single legal entity.

“I think [the regulators] are giving us flexibility to figure out how to make it work,” said Dechert partner Rick Jones.

Renna at the CRE Finance Council said that if the regulators were concerned about different sources of capital teaming up to purchase B-pieces, “they would have written something into the rule to prevent it, and they didn’t do that.”

Still, some investors said they’d be wary of using structures that would appear to directly flout the regulators’ prohibition of senior/junior B-pieces and might prompt the agencies to issue clarifications that would block such maneuvers. In adopting the rule, the regulators stated that “allowing the third-party purchasers to satisfy the risk retention requirement through a senior-subordinated structure would significantly dilute the effectiveness of the risk-retention requirements.”

A number of bond pros noted that the rule doesn’t prescribe penalties for failure to follow the risk-retention mandate. But presumably the individual agencies that collaborated on the rule will devise enforcement measures. There’s speculation the lead role would go to the SEC, which oversees disclosure and other rules for securities issuance. Jones pointed out that the ultimate responsibility for compliance lies with the issuer — raising questions about what would happen if a B-piece buyer doesn’t live up to its risk-retention obligations.

Many are forecasting that the number of firms competing for B-pieces — which in recent months has grown to as many as 17 — will shrink as the need for more capital gives large companies an advantage.

“I’m hearing people call this a ‘big institution rule,’ ” said one investor. “That means it’s good for the big guys, like BlackRock or Rialto Capital, and bad for the little guys. Their cost of capital is going to keep them out of the game.”

When it comes to forming new funds or partnerships, “the money will coalesce around the best-in-class guys,” one investor said. “The institutional guys — the pension funds, the endowments — will decide that a handful of [B-piece buyers] are good at this, and those will be the guys who survive.” That investor expects fewer than 10 competitors to remain.

Fewer bidders, larger buyers and the mandate that third-party purchasers hold the bonds for at least five years will add up to wider spreads on the new B-pieces, experts predict. That would reverse the recent trend that has seen yields shrink as more shops have competed to win deals.

The bigger shops likely will be able to negotiate deeper discounts because they have the capacity to take down the thicker slices. In addition, buyers will demand a pricing premium for the loss of liquidity.

“B-piece buyers get a yield of around 14.5% now, and I wouldn’t be surprised to see that go up to as much as 17.5%,” said one sell-side executive. He added that loan kickouts will likely become more common under the new regimen.

“B-piece buyers can either ask for a price adjustment or they can kick out loans,” he said. “But if they price-adjust under the new rules, and the price drops, that will make it harder to [reach] the 5%-buy requirement. So instead of price adjustments they will probably be kicking out more loans.” That would promote one goal of the regulators: improving the credit quality of securitizations.

Several experts pointed out that the market has two years to figure out the details. And some expressed hope that the regulators would adjust or clarify their positions in response to questions and concerns raised by the industry.

“We’ve got two years . . . which is forever in Washington,” said Jones at Dechert. “Just because it’s final doesn’t mean we’ll stop talking.”

Federal Housing Finance Agency Unveils Plan to Loosen Rules on Mortgages

For years, politicians, housing advocates and potential home buyers have complained that tight credit policies after the housing market crash have kept too many deserving people from qualifying for mortgages.

Now the government is taking steps that it says it hopes will allow more first-time buyers and lower- and middle-income Americans to get home loans at low rates.

On Monday, Melvin L. Watt, the nation’s chief housing regulator, announced a program offering more reassurances to mortgage banks that fear they could suffer unpredictable losses on the loans they sell to the government.

Separately, he disclosed that efforts are underway to allow borrowers to receive government-backed loans with much smaller down payments than are now required. But contrary to early expectations, he offered few details on such plans.

“We know that access to credit remains tight for many borrowers, and we are also working to address this issue in a responsible and thoughtful manner,” said Mr. Watt, director of the Federal Housing Finance Agency, which regulates the mortgage finance giants Fannie Mae and Freddie Mac.

The move in large part is intended to reassure banks that have had to pay tens of billions of dollars to settle legal cases arising from the housing boom and bust and buy back bad loans sold to Fannie and Freddie. To avoid having to make those payments again, many lenders now demand that borrowers meet stricter requirements for loans, known in the industry as overlays.

“We know that this issue has contributed to lenders’ imposing credit overlays that drive up the cost of lending and also restrict lending to borrowers with less-than-perfect credit scores or with less conventional financial situations,” Mr. Watt said in a speech on Monday to the Mortgage Bankers Association convention in Las Vegas.

Some economists, with mortgage bankers, welcomed the new plan, saying that it, with more gains in the job market and a recent dip in mortgage rates, could put the housing recovery back on track. Ben S. Bernanke, the former chairman of the Federal Reserve, recently told an audience that even he could not get a loan to refinance his mortgage.

“Creditworthy borrowers who have been locked out of the housing market will finally have an opportunity to become homeowners,” said Mark Zandi, chief economist at Moody’s Analytics.

But some housing finance analysts contend that tight credit does not sufficiently explain the weakness in the housing market. Instead, they say, an aging population, stagnant wages and a wariness of taking on new debt have all reduced demand for mortgages.

“The reality is that this is as much a demand-driven drought as it is a credit-driven drought,” said Joshua Rosner, of Graham Fisher & Company, a research firm.

With the new plan, the government is trying to strike a balance between the frenzied years of the housing bubble, when mortgages were approved with little regard for the ability of borrowers to repay them, and the tight grip on mortgages after it burst.

“It requires a lot of fine-tuning to get a national mortgage market that achieves all the objectives we want,” said Stan Humphries, chief economist for Zillow, a real estate website.

To reassure mortgage lenders, the housing finance agency intends to further relax the agreements that determine when Fannie and Freddie may require banks to buy back bad loans. The terms that are being loosened involve loans that show evidence of fraud or other flaws in the underwriting process.

Under the new agreements, for instance, Fannie and Freddie would demand buybacks only when there was a pattern of misrepresentations and inaccuracies in the loans. In addition, if problems are later discovered in loans, the deficiencies would have to be significant enough to have made the loans ineligible for purchase by Fannie and Freddie in the first place.

These changes follow other recent adjustments by the housing finance agency to calm mortgage lenders. But mortgage banks did not increase lending to less creditworthy borrowers.

Now, some housing specialists are more hopeful that the overhaul announced on Monday will prompt the banks to lend more. “It will be helpful in moving the needle,” Jim Parrott, a senior fellow at the Urban Institute, said.

Mr. Watt said he would give specifics in a few weeks about a plan for borrowers that could include down payments of as little as 3 percent.

Borrowers can already apply for low down-payment loans that are backed by the Federal Housing Administration. But housing specialists said that some borrowers who qualified for loans backed by Fannie and Freddie were being directed to the F.H.A., which backs loans that have much higher interest rates.

“You want people to get the loan they qualify for,” said Michael D. Calhoun, president of the Center for Responsible Lending.

$278.1Bln of Conduit Loans Mature in ‘15-’17

A total of 22,514 CMBS conduit loans with a balance of $278.1 billion come due in the next three years. While a seemingly massive wall of maturities, the volume has shrunk by nearly 10 percent over the past nine months. And given continued favorable lending market conditions, it’s likely to continue shrinking.

Indeed, just about every major investor group has increased its holdings of commercial mortgages, according to recent data from the Mortgage Bankers Association, which found that the universe of outstanding commercial mortgages increased by 1 percent during the second quarter to $2.6 trillion.

Banks and thrifts, the largest holders of mortgages, saw their inventory of loans increase by a robust 1.8 percent over the first quarter, to $929.9 billion. CMBS and other securitized vehicles saw their inventory decline to $532.9 billion. That’s largely due to the fact that run-off outpaced new originations - at least through the second quarter. Life-insurance companies, meanwhile, saw a 1.3 percent increase in their inventories, to $345.8 billion.

The open lending spigots have led to a steady pace of loan pay-offs - a big chunk of the loans being securitized today were written to refinance existing CMBS loans - as well as a sharp increase in the volume of defeasance, where loan collateral is replaced by government securities.

Wells Fargo Securities noted that so far this year $12.4 billion of CMBS loans have been defeased, or replaced by government securities. That compares with a volume of $11.3 billion for all of last year and amounts to a near doubling of the $6.4 billion of volume recorded during the year’s first half.

Next year, 6,263 conduit loans with a balance of $64.6 billion come due. In 2016, that increases to 8,230 loans with a balance of $104.3 billion and in 2017, 8,021 loans with a balance of $109.2 billion come due. The volume excludes loans that have been defeased. Because those are backed by government securities, they aren’t at risk of defaulting at maturity.

Even though the volume of loans that mature between 2015 and 2017 steadily has been declining, many of the remaining loans could pose challenges. The thinking has been that loans that easily could be refinanced would have been by now, simply because interest rates are lower than they were when the current crop of maturities were written.

A total of 9,482 loans with a balance of $153.8 billion, or 55 percent of the loans that mature during the 2015-2017 period, have debt yields of 10 percent or less, based on the latest available net operating income figures as compiled by Trepp LLC.

A loan’s debt yield is calculated by dividing a collateral property’s NOI by its loan’s balance and is a gauge used to determine how comfortably the property can carry its debt.

Meanwhile, the collateral for 5,351 loans with a balance of $64.9 billion generates less than 10 percent more than what’s needed to fully service their securitized loans. In other words, their debt-service coverage ratios are less than 1.1x. Lenders typically prefer loans whose collateral can generate 120 percent, or 1.2x, the cash flow needed to fully service their borrowings.

Using DSCR as a gauge, office loans could face the biggest challenges in refinancing, as 1,209 of the loans coming due between 2015 and 2017, with a balance of $27.6 billion have DSCRs of less than 1.1x. Of the retail loans that will be coming due between those years, 1,941 with a balance of $22.8 billion have DSCRs of less than 1.1x.

Among those that might face challenges are the $200 million loan, securitized through Banc of America Commercial Mortgage Trust, 2005-3, against the Woolworth Building in Manhattan. The 811,791-square-foot office property last year generated $12.7 million of net cash flow, which is about 20 percent more than that needed to fully service its non-amortizing loan. But the $13.6 million of NOI it produced results in a debt yield of only 6.8 percent. The well-leased property also supports $50 million of additional debt. And its largest tenant, the General Services Administration, occupies its 112,692 sf under a lease that matures next October. It leases its space on behalf of the SEC, which had reduced its footprint in the building when its lease originally matured two years ago.

New Risk Rules Add Hurdle for Project Loans

Impending changes in the risk-based capital rules for banks are starting to affect the terms and pricing of some high-leverage construction loans.

The U.S. version of the "Basel 3" guidelines, which take effect Jan. 1, sharply increases the amount of capital banks must hold in reserve against "acquisition, development or construction" loans unless the leverage is 80% or less and the borrower’s up-front capital contribution is at least 15% of the project’s value.

While most bank loans would fall well under the 80% leverage limit, the equity requirement is proving to be an obstacle for some deals — largely because the 15% threshold is based on the estimated value of a project "as completed," rather than the cost of construction.

As they start negotiating loans that may close after the first of the year, banks are informing borrowers that they’ll need to put up enough cash to meet the new requirement, or pay a higher interest rate to compensate for the cost of holding additional risk-based capital, according to industry pros.

Complicating the calculations are some gray areas in the new regulations, adopted last year by the

Comptroller of the Currency, the Federal Reserve and the FDIC to conform with the Basel 3 standards set by the Bank for International Settlements. The regulators haven’t spelled out just what "as completed" means, said George Green, associate vice president of commercial/multi-family policy at the Mortgage Bankers Association.

"Is that stabilized, is it non-stabilized?" Green said. "The value of an income-producing property is based on its leased income. Significantly different values are generated if a building is substantially leased versus minimally leased."

The higher the projected value of the completed property, the more cash the borrower would have to provide upfront to reach the 15% threshold. The rules also mandate that those funds remain committed to the project until the loan is retired or converted into permanent financing meaning the developer can’t draw out leftover cash as a project nears completion.

Construction loans that don’t meet the leverage and borrower-equity requirements must be treated as "higher volatility commercial real estate" under the Basel 3 rules. Loans in that category will be subject to a risk weighting of 150%, while most other commercial mortgages will be weighted at 100% and certain multi-family loans will qualify for a 50% weighting. Banks are generally required to hold capital against 8% of the balance of their loans, but the higher risk weighting will bump that up to 12%.

While many banks have already set new lending standards in response to the rules, others are still working out the details. "It seems more banks are just waking up to this new regulatory environment," said one originator.

Some banks are starting to put language into preliminary loan agreements stating that the proposed pricing can change if the estimate of the project’s "as completed" value comes back higher than expected and the borrower’s equity doesn’t reach 15% of that figure.

One broker said he was already seeing signs that some banks are cutting back on construction lending to avoid the new capital charges.

Another industry pro said he knew of a few cases where banks walked away from potential deals when their calculations showed the loans would fall into the higher-volatility category.