Lenders and special servicers are looking beyond refinancing options when it comes to working with borrowers on commercial real estate loans that are set to mature in the coming months and years, even as those loans increasingly are backing properties facing distress.
According to an analysis by Moody’s Investors Service, the percentage of real estate properties that use commercial mortgage-backed securities debt that are being refinanced is on the decline. Conduit refinance rates were 78.1% and 71.8% in the first and second quarter of this year, respectively, compared to 85.5% in 2019, the year before the Covid-19 pandemic and broader economy upended the commercial real estate market.
Matthew Halpern, vice president and senior credit officer at Moody’s Investors Service, said given the low interest-rate environment that existed before the pandemic, it wasn’t surprising to see so many loans refinanced then, especially if a borrower had a strong debt-service coverage ratio, which measures available cash flow versus debt obligations.
Interest-rate hikes imposed by the Federal Reserve over the past year in the wake of rising inflation have compressed real estate values. Add to that rising vacancy rates and a weaker leasing environment in especially the office sector, and the pressure has increased on building owners with loans coming due in the near term.
“Some loans are performing well from in-place cash flow but are unable to refinance,” Halpern said.
Lenders also have tightened standards in the wake of a more challenging economy and commercial real estate market, with some banks outright saying they’ve stopped new lending to office properties.
While fewer loans are getting refinanced overall, there’s been an uptick in the number of performing loans that are past maturity but haven’t been formally extended. That amount, negligible before the pandemic, reached 5.2% in Q1 of this year and 6.9% in Q2.
Halpern said that means the borrower is still making interest and principal payments as if the loan hadn’t matured — which typically suggests the borrower is committed to the property. Because the overall refinance rate has declined in recent quarters, the number of performing loans past maturity has naturally risen, he said.
The Moody’s analysis, which only examined CMBS loans, found 16.7% of maturing loans tracked by the firm were delinquent as of the second quarter. That share was much higher in the office sector, with 27.6% of office loans scheduled to mature in Q2 2023 considered delinquent.
Extend and pretend
What ultimately happens to a loan at maturity is entirely dependent on the nuances and financial performance of a property, not to mention the borrower. But “extend and pretend,” industry parlance to describe lenders extending terms on a loan for a property facing a loss in value instead of initiating a foreclosure, is being observed to some extent, according to industry analysts.
Moody’s found 2.5% of performing conduit loans set to mature in Q2 2023 were extended, down from 5.6% in Q1 2023 and more than 7% in the second half of 2022. Among performing conduit loans in the office sector, 1.3% were extended in Q2 2023, down from 10.9% in Q1.
Halpern said extensions aren’t a new thing in CMBS and, during a market dislocation, if a borrower is committed to improving its property, an extension on a loan is generally seen as better than a fire sale, he said. For an office property that’s historically performed well on quality, tenancy and cash flow but is facing a significant lease rollover in the next year or facing other imminent issues, a loan extension of one or two years, with the addition of a “cash trap” — a provision that would allow a lender to redirect surplus cash into an account it manages — could be put in place.
For some loans on the cusp of maturing, the ability to refinance may require more cash from the borrower, especially as lending standards have tightened.
Belinda Schwartz, executive chair, co-chair of the real estate department and partner at New York-based Herrick Feinstein LLP, said the “haves and have nots” have emerged as commercial loans mature. That sentiment is being observed among lenders and borrowers alike, as some owners have walked away from underperforming office buildings.
“There are certain people who have the ability to put capital into certain buildings, but then they’re picking their favorite children and saying, ‘Which are the assets where it make sense to put more money into, because it’s going to be worth it to do so?'” she said.
A lot also depends on a property’s capital stack and the its backers, Schwartz said. Bank lenders, debt funds and preferred equity players all have different models and potential willingness to take a distressed property back if a borrower defaults.
For building owners facing a looming maturity, it’s possible to work out a resolution if they have a good relationship with their lender or have a strong reputation in the industry, Schwartz said.
But the specific environment facing both the commercial real estate and banking world right now hasn’t been observed in past cycles, even in severe recessions like the global financial crisis of 2007 to 2009, making it difficult to ascertain what ultimately will happen with the wave of debt coming due soon. What’s happening now is only the tip of the iceberg, Schwartz said.
“This is a tough one because I’ve never, ever experienced this set of facts,” Schwartz said. “A lot depends on what happens in the bank industry more generally. The political climate is also complicated to navigate: Will the regulators find a way to help? I think there are so many unusual factors. … While my gut says (there’s) going to be a lot of pretend and extend, we are seeing a tick up in foreclosures.”
Source: “Fewer CRE loans being refinanced, but lenders find other ways to work with borrowers“
