Small-Balance CMBS More Prone to Delinquency

MBA (8/19/2008 ) Murray, Michael
Small-balance loans in United States commercial mortgage-backed securities pools trend higher in delinquencies than larger loans, based on industry data.
The most recent Loan Delinquency Index from Fitch Ratings, New York, said small balance transactions issued between 1999 and 2007—in 16 out of 478 transactions or less than 3.5 percent of deals—totaled nearly $4.8 billion. This year, however, small balance delinquencies increased.

“We see substantial differentiation in the performance of small balance pools, compared to that of traditional CMBS pools,” said Susan Merrick, managing director and head of the U.S. CMBS group at Fitch. “For instance, Fitch’s year-to-date upgrade-to-downgrade ratio of 2.5-to-1 for traditional CMBS was driven to 1.5-to-1 when small balance transactions were factored in.”

Small balance loans in CMBS pools—from $150,000 to $15 million—accounted for less than 1 percent of all loans in the Fitch-rated universe but contained 10.8 percent of all delinquencies. Current small-balance CMBS delinquent loans included more than 5.4 percent of loans in Fitch’s July loan delinquency index, compared to 0.38 percent delinquent for all traditional commercial loans rated by Fitch.

Standard & Poor's, New York, said commercial mortgages with larger loan balances are generally less likely to default—or reach 60 days delinquent for the first time—than those with smaller loan balances.

In the ratings agency's most recent default study—including 59,348 loans issued between 1993-2006—default rates for loans with original balances above $100 million was "very low" at .19 percent, said Larry Kay, director of structured finance ratings at Standard & Poor's.

The study showed a default rate for loans with original balances between $1 million and $5 million at 4.92 percent. Below $1 million loan balances, the default rate hit 5.31 percent.

"Borrowers of large loans tend to be better-capitalized than small-balance borrowers and usually employ professional property management companies," Kay said. "Properties backing large loans are typically located in primary markets and may generate more interest for investment and/or refinance [and] large loans have higher exposure in a rated CMBS transaction. They are usually subject to more scrutiny from investors, issuers and others."

"While we are beginning to see some larger balance loans [above $15 million] default in the more recent vintage transactions, this is mostly based upon the mere size of the deals and inclusion of larger balance loans across the board. The majority of loan delinquencies continue to fall below that cutoff by loan balance," said Frank Innaurato, managing director at Realpoint LLC, Horsham, Pa.

Realpoint reported that in June, nearly 15 percent—14 of 97 newly reported loans at least 30 days delinquent—had unpaid balances of more than $15 million, including 11 loans at more than $20 million.

In May, less than 8 percent of loans had unpaid balances of more than $15 million—with less than 5 percent above $20 million. In April, 14 of 149 newly reported loans were at least 30 days delinquent with unpaid balances above $15 million, including eight above $20 million, Realpoint reported.

Small balance loans from the 2006 CMBS loan vintage added nine basis points to Fitch’s individual loan delinquency index. The vintage’s loan delinquency rate would drop to 0.26 percent from 0.35 percent without small balance loans issued that year. The 2006 vintage contains nearly $600 million—or nearly 25 percent of the total index amount—and the highest dollar balance of loan delinquencies within Fitch’s delinquency index.

Dropping small-balance CMBS from the 2007 vintage would bring that year’s individual loan delinquency index four basis points lower to 0.15 percent. The 2007 vintage reflects 12.5 percent of all delinquencies in the index—based on high transaction volume percentage that year, Fitch said. Realpoint’s review of 2007 vintage found 11 percent of total CMBS delinquent.

Nearly 40 percent of all delinquent unpaid balances through June came from transactions issued during 2006-2007, with more than 23 percent of all delinquency found in 2006 transactions, Realpoint said.

CMBS issuance in 1998—with a large percentage of 10-year term loans—reflects 15.4 percent of all delinquencies within Fitch’s loan delinquency index. Nearly 4 percent of all loans issued in 1998 are delinquent, and Fitch said nearly 10 percent of all delinquent loans from the 1998 vintage are “non-performing matured” loans.

Fitch said individual borrowers or small businesses with less commercial real estate experience than most traditional CMBS borrowers typically receive smaller CMBS loans and contribute to higher delinquencies.

Underwriting of FICO scores as a measure of borrower creditworthiness—compared to CMBS underwriting and greater reliance of property cash flow to support debt service coverage—also contribute to the delinquency rate.

Deferred maintenance and few, if any, structural reserves on older properties collateralizing small-balance loans could also contribute to higher delinquencies, Fitch said. The ratings agency recorded 0.35 percent delinquency for all 2006 CMBS transactions and 0.19 percent delinquent for the 2007 vintage—large and small. Total U.S. CMBS delinquencies increased two basis points in July to end the month at 0.43 percent.

The seasoned delinquency index, which omitted transactions with less than one year of seasoning, increased by one basis point to end the month at 0.48 percent. Six transactions at $22 billion were newly seasoned, and four newly-seasoned delinquent loans totaled $62.7 million, Fitch said.