Last night, Kroll Bond Rating Agency (KBRA) sponsored a CREFC after-work seminar and panel discussion on the current state of CMBS 2.0 performance with topics ranging from servicing pain points to troubled loan workouts. The panel was moderated by Keith Kockenmeister, Senior Managing Director and Co-Head of the CMBS group at KBRA. Six panelists representing investors (AIG), servicers and special servicers (Wells Fargo, PNC Real Estate/Midland Loan Services, and CW Capital), operating advisors (Park Bridge Financial) and rating agencies (William Petersen, Managing Director, KBRA) were present.
Eric Thompson, Senior Managing Director and head of the Real Estate Group at KBRA, kicked off the evening with opening remarks to frame the importance of the evening’s discussion. With interest rates rising and ahead of the next economic and real estate downturn, it seemed like an opportune time to discuss credit performance, servicing, and surveillance of CMBS 2.0. While CMBS 2.0 delinquencies are still at very low levels, there has been a noticeable increase in appraisal reduction amounts (ARAs) which some market participants believe are a proxy for expected loan losses.
The panel discussion opened with a rundown of CMBS 2.0 credit performance as William Petersen provided an overview of delinquencies, KBRA’s Loans of Concern (K-LOCs) and rating actions. In KBRA’s rated universe of CMBS 2.0 deals specially serviced loans remained low at 0.6% and delinquent loans at an even lower 0.45%. The low delinquency rate along with the healthy economy and commercial real estate fundamentals has led to a positive upgrade to downgrade ratio of more than 5:1 with almost all of the downgrades coming from non-investment grade classes. It was highlighted that offsetting the positive performance was the level of K-LOCs, which have grown to 3.6%. This is an indicator that over the next 12-18 months KBRA anticipates a potential increase in the amount of non-performing loans from today’s low levels.
While CMBS is benefitting from a healthy economy, a fair amount of time was spent by the participants outlining how they are preparing for any potential downturn in the markets, which many predicted was two to three years away. The servicer, special servicer and operating advisor panelist all emphasized that while things were relatively quiet in CMBS 2.0, they were developing and improving processes, investing in technology and people, and cultivating the communication and interaction between deal participants. This will put them in a better position to anticipate the problem loans and be better prepared to meet the challenges ahead whenever the downturn happened. Examples mentioned included frequent dialogue and review of watchlist loans between the operating advisor, special servicer, servicers, and directing certificate holders; tracking and understanding the nuances of control rights of split loans; and, enhance management of the increased level of loan triggers seen in loans. The panelists agreed that these proactive efforts could make a key difference in the handling of troubled loans when the next downturn comes.
Key challenges highlighted by panelist during the evening focused on the non-standardization of loan agreements and Pooling and Servicing Agreements (PSAs). This has been exacerbated by the amount of split loans in the market including examples where loans were split among 10-12 deals. The level of split loans and the non-uniformity of documents has required each participant to spend a significant amount of resources to track and document the pari passu note pieces and nuances of each loan and transaction. One suggestion was to create an industry database that could house and track all the split loan pieces and some of the control issues that go with them.
It was acknowledged that as much as the industry improves and enhances transparency and reporting for investors, changes to loan terms and structures that address a specific issue or concern, like risk retention or balance sheet management, has had a way of increasing complexity. It was mentioned however, that at the end of the day, while many will be happy with implemented changes, you can’t please everybody.
Tangentially this raised the issue of borrower satisfaction. Despite the efforts taken by all the players to improve the borrower experience, the nature of having multiple parties, creating loans with numerous triggers, and non-standard PSAs has continued to make borrower’s less inclined to participate in a CMBS loan execution. One issuer has recently introduced a borrower liaison contact to make the borrower/lender process more seamless.
The evening wrapped up with a few short answer questions to the panelists. Most telling was the question - what keeps you up at night? The answers varied from one panelist to the next and covered the gamut of industry issues. Answers included the unknown of the next disruptive market event that could affect the commercial real market, the economics of servicing and being an operating advisor when there are significant increases in problem loans later in a deal’s life, the fading memory of the last downturn and resulting complacency, the ability to hire and retain staff, and the heightened regulatory and compliance environment.
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KBRA is a full service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus, is recognized by the National Association of Insurance Commissioners as a Credit Rating Provider, and is a certified Credit Rating Agency (CRA) by the European Securities and Markets Authority (ESMA). Kroll Bond Rating Agency Europe Limited is registered with ESMA as a CRA.