Low CMBS Delinquencies Stress Subprime Contagion

MBA (6/5/2008 ) Murray, Michael
Rating agency stress tests and delinquency studies continue to distance commercial mortgage-backed securities from subprime residential mortgage-backed securities as the CMBS market grapples with subprime contagion and problem borrowers.

In a new report, Fitch Ratings, New York, said a 15 percent drop in property values would do relatively little to adversely impact the credit ratings of older vintage U.S. CMBS, including tranches deemed impaired. The report tested fixed-rate loans maturing through 2012, and Fitch concluded that the older CMBS vintages were “well-insulated” from a 15 percent drop in property value.

The floating-rate loans, with final extension options, had a similar scenario to the fixed-rate loans and would likely extend to 2010. The loans include outside debt—large B notes, junior participations and mezzanine debt.

While 138 of the 1,381 total classes were considered “impaired,” 20 of those tranches were investment grade level, Fitch added. By class balance, 97.8 percent were considered not impaired, or $74.1 billion of the $75.8 billion tested.

“Not only would they not take a loss but we considered the stressed credit enhancement okay to support the current rating,” said Britt Johnson, senior director of the CMBS group at Fitch Ratings.

The 2006-2007 CMBS vintage—considered by some industry participants to include “lax underwriting” based on a plethora of capital given to borrowers based on floating-rate pro-forma calculations—were not included in this stress test.

Johnson said Fitch will be publishing the results of stress tests on the 2006-2007 vintages within the next month. However, if the 2006-2007 vintage CMBS loans turned out to be as favorable as the seasoned loans from the most recent stress test, then “subprime contagion” would be an issue, she said.

“I think that there are a lot of differences between commercial real estate and residential real estate and subprime and CMBS,” Johnson said. “I think we are finding, overall, when we are reviewing transactions—even 2006 and 2007 vintages that we have reviewed so far this year—for the most part, they are performing pretty stable.”

Federal Reserve Gov. Ben Bernanke, speaking Tuesday via satellite at the International Monetary Conference in Barcelona, Spain, said despite improvement in the function of financial markets, conditions “remain strained and some key funding and securitization markets have shown only tentative signs of recovery.”

“Some borrowers, such as highly-rated corporations, retain good access to credit, but credit conditions generally remain restrictive in areas related to residential or commercial real estate,” Bernanke said.

In recounting the subprime mortgage crisis and the credit crunch, Bernanke tied the current state of the CMBS market to subprime contagion and lack of investor confidence.

“Notably, as subprime losses forced the credit rating agencies to downgrade what had been highly rated mortgage-backed securities, investors also came to doubt the reliability of ratings that had been awarded to other highly complex securities,” Bernanke said. “As a result, investors became much more cautious and reversed their aggressive risk-taking of the credit boom period. The resulting pullback affected a much broader range of securities, including leveraged and syndicated loans, asset-backed commercial paper, commercial mortgage-backed securities and a variety of structured credit products. Large financial institutions, especially in the United States and Europe, were particularly affected by these events, having reported a total of roughly $300 billion in writedowns and credit losses.”

Alan Todd, head of CMBS research at J.P. Morgan Securities, New York, said CMBS delinquency rates continue to tick up but still remain low versus historical comparisons. By dollar balance, however, he noted that they are now near all time highs.

"Multifamily loans remain the clear underperformer with 60-plus day delinquency rates several times higher than other property types," Todd said.

In May, Fitch Ratings said it reviewed all of its transactions with MBS Cos. exposure from the last 60 days and concluded that MBS loan defaults—$407.4 million in 18 Fitch-rated CMBS deals with exposure to MBS Cos.—would have little effect on investment-grade CMBS bond ratings. Rating downgrades were at below investment-grade classes as eight classes were downgraded or placed on Rating Watch Negative—primarily due to increased loss expectations on the MBS Cos. collateral.

The ratings agency continues to monitor the impact of existing loans from MBS Cos., a large borrower of loans backed by Texas multifamily properties, which started to default in December 2007. Nearly half of MBS Cos. loans in Fitch-rated transactions, by balance, are in bankruptcy, with 22 percent in foreclosure and 8.1 percent REO. Fitch expects 3.8 percent of loans to pay off with losses and 22 percent of the loans to remain current with one loan—nearly 2 percent of the total—paid in full.

The average value of the MBS properties—compared to appraisal values at the time of securitization—declined by 14.5 percent, with the 2001 vintage experiencing the highest rate of value decline at 45.8 percent, and the 2007 vintage experiencing the lowest rate of decline at 3.7 percent.

The ratings agency said that in some cases, loans servicers successfully resolve MBS Cos. loans through reorganization and assumption of debt, which is expected to return the loans to performing status.

"The percentage of outstanding loans that are specially serviced or watch listed shot up sharply in May,” Todd said. “The percentage of outstanding loans on watchlist jumped 1.35 percent in May, the largest jump since 2003. The overall percentage of loans on watchlist now stands around 13 percent."

Johnson said Fitch would continue to monitor the 2 percent of CMBS deals considered impaired, but the loans would not receive a “rating watch negative” and would not likely be downgraded due to the amount of stress placed on the loans during the test. The ratings agency also continues to monitor the 2006-2007 vintage.

“It is obviously something that we are going continue to look at and [we] continue to evaluate our portfolio to continually provide updates on how CMBS is performing but, so far, we have not seen significant negative events in CMBS,” Johnson said.