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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   January 2017

Hitting the Wall of Maturities

A significant slice of CMBS debt will face challenging refinancing hurdles

Many market watchers are anxiously keeping an eye on the wave of maturing loan debt that secures billions of dollars in commercial mortgage-backed securities (CMBS). Some market observers believe that rising property values over the past few years and the current abundance of available capital should ensure that the CMBS loans will pay off at maturity.

Still, there has been much speculation about the health of a particular slice of maturing CMBS loan volume, which was originated during the heady bubble years of 2005–2007. The concern is that many of those CMBS loans will not be paid off or secure refinancing as their 10-year terms reach maturity through 2017. The cracks in that wall of maturities started to become more visible as we entered the final quarter of 2016.

As of this past September, the year-to-date payoff rate for CMBS loans maturing in 2016 was 75.6 percent — meaning about 24 percent didn’t make the cut. The average CMBS loan-payoff rate for the entire year is projected to be between 70 and 75 percent, according to Morningstar Credit Ratings LLC. For 2017, the on-time payoff rate is expected to dip even lower. By comparison, the 2015 average payoff rate was about 80 percent.

Morningstar’s examination as of September 2016 of the loan-to-value (LTV) ratios on CMBS loans maturing in 2016 makes clear why some 30 percent of the loans were not expected to pay off on time for the year. Many of those CMBS loans are overleveraged and loosely underwritten.

Having a realistic outlook on the trajectory of the CMBS loan market, and the payoff and refinancing prospects for that debt, can provide commercial mortgage brokers with an edge in helping affected clients line up workable deals.

Creative refinancing

Many people in the commercial real estate industry believe that high-LTV, creatively structured debt instruments will serve as the refinancing tools for the overleveraged CMBS loans that likely won’t be able to pay off at maturity. In some instances, that might be the only thing required to refinance the existing debt. In many cases, however, the leverage on the CMBS loans is so extreme that there is no financing vehicle available to prevent default. Let’s break this down more simply.

For maturing loans with an LTV of 80 percent or less and/or a debt yield above 8 percent, representing about 51 percent of the total remaining maturities for 2016 as of this past September, the borrower should be able to find refinancing sufficient to pay the existing loan off. In some cases, these borrowers are opting to sell the property as a way to pay off the debt.

Although creative capital sources, white knights, joint-venture partners and other hard money sources exist in the market, they are likely not a magic solution.

For maturing loans with an LTV of 80 percent to 100 percent, representing some 19 percent of maturing CMBS loans in 2016 as of this past September, according to Morningstar, the prospects for finding refinancing are a bit more complex. In terms of weight, nearly three-quarters of this CMBS loan slice falls in the LTV range of 85 percent to 100 percent.

Borderline options

For CMBS loans with an LTV of 80 percent to 85 percent, an alternative high-LTV, creatively structured debt instrument may be the solution. Keep in mind that this high-leverage refinancing is expensive and typically has a very short term. Consequently, it will likely only work for the borrower if the property is projected to increase significantly in value in the next few years. This kind of debt instrument often comes in the form of mezzanine financing or bridge loans.

For maturing loans with an LTV of 85 percent to 100 percent, however, there are a lot more dynamics to consider. Will an extension of the existing loan by a few years provide for a full payoff at the extended maturity date?

If so, an extension may be worth considering, although keep in mind that they are very expensive and should be considered the “last resort.” Many owners are resorting to selling the property when the LTV is in the range of 85 percent to 100 percent because of the limited options available to them. Any outside funding source in this LTV range normally works like a joint venture. The funding source will likely want to have some ownership stake in the property, and the cost of these funds is very high.

Beyond salvation

The most difficult category of loans is where the current LTV is greater than 100 percent. This slice represented some 30 percent of CMBS loans maturing in 2016 as of this past September, Morningstar reports.

There is no amount of creative high-LTV debt financing that will cure these overleveraged deals. A sale won’t work either unless, of course, a buyer is willing to pay more than the property is worth.

A term extension can only be considered if the borrower can pay the loan down to a reasonable LTV, which presumably most owners won’t want to do. Unfortunately, the only options available to the owner here are to hand the property over to a trust, or to get approval for a discounted payoff, which special servicers are not generally inclined to do in today’s market.

Many of the properties in this category are going back to the CMBS trusts — either through a foreclosure or a deed in lieu of foreclosure — which likely means large losses for the CMBS bondholders when the trusts eventually sell the properties. The payoff picture for maturing CMBS loans in 2017 looks troubling as well, with only an estimated 60 percent or fewer maturing CMBS loans expected to pay off on time — based on nearly 47 percent of the loans having LTVs exceeding 80 percent, according to Morningstar data. That compares with a projected CMBS loan-payoff rate of 70 to 75 percent for 2016.

As a result, the prospects for CMBS loan refinancing in the year ahead are even bleaker for a large swath of the market. Although creative capital sources, white knights, joint-venture partners and other hard money sources exist in the market, they are likely not a magic solution for addressing the excessive CMBS loan leverage created in the bubble years during the mid-2000s.

•  •  •

When a property owner has a CMBS loan with higher leverage than today’s lending market will bear, it is incumbent on the commercial mortgage broker and his client to understand the options well ahead of the loan’s maturity date. Unless the property owner is willing to invest a lot of new capital to pay off the existing loan, other more painful options will have to be pursued, and they all take time.

Consequently, brokers working with property owners that are locked into maturing CMBS loans should carefully assess the status of the loan and the level of leverage to determine the best course to take in seeking out future financing solutions.


 


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