By: John O'Callahan
Having just passed the five-year anniversary of the 2008 financial crisis peak, it’s a good time to review the impact of pre-crisis over-exuberance and excessive leverage on CMBS.
Total legacy U.S. CMBS 1.0 loan balances declined to $450 billion at the end of the third quarter from $825 billion at the end of 2008, as shown in Exhibit 1. (1)
Servicers liquidated approximately $65 billion in loans that lost a total of $28 billion over the past five years. Another $20 billion of defaulted loans either finally paid off or were liquidated with no losses. Total cumulative losses in the U.S. CMBS space have reached $32 billion, including losses sustained before the crisis.(2)
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As anticipated, loans originated before 2004 have been largely paid down, and only 3% of original balances, or $15 billion, remains.(3) Cumulative losses from this cohort, totaling $9.5 billion, are less than 2% of original balances, and only another $1.7 billion in losses is projected over the next few years.
Most of the remaining CMBS 1.0 balances will decline rapidly over the next five years as payoffs and liquidations take their toll.
In the near term, liquidations and realized losses are expected to continue to accrue at a high rate, leading to cumulative CMBS losses exceeding $50 billion by the end of 2015.(4) Monthly liquidation volumes may be lumpy as special servicers try a new tactic of selling pools of nonperforming assets via auction.
CWCapital’s $2.9 billion auction sale, slated to close in early 2014, follows Orix’s $1 billion pool sale in June. More pool sales could speed up the resolution of $40 billion in outstanding troubled loans (half of which is REO), but the lack of clarity around which assets will be sold at auction will give investors heartburn as they grapple with uncertainty over the timing of principal cash flows.
GSMS 2007-GG10, for example, could endure a surge in both loss amount and bond paydown after CWCapital’s upcoming pool sale, possibly exceeding PPR’s 20-month-old prediction for 8% losses in this deal by the end of 2013.5
After 2015, loss severities will begin a relatively steep decline as troubles shift to maturity defaults. Final cumulative losses are projected to level out at around $70 billion (depending on market takeout assumptions for refinancing)-marginally lower than our 2010 projections-as a result of improved conditions.(6)
On many fronts, we’re roughly at only the halfway point from the crisis peak for legacy CMBS, in terms of losses realized and balances and time remaining.
On the bright side, disappearing vintage balances are being replaced by CMBS 2.0/3.0 balances ($138 billion currently) and agency multifamily MBS ($152 billion). PPR anticipates that overall U.S. CMBS balances of all types and vintages-currently totaling $740 billion-will slowly grow in the near term as origination volume exceeds dispositions. And CMBS continues to be an attractive asset class for a wide range of investors.
(1) Data is for all U.S. CMBS, including conduit, fusion, single asset/borrower, floating-rate CMBS, and agency MBS.
(2) Over $1.2 trillion of U.S. CMBS loans (all loan and deal types) were securitized through 2008.
(3) $480 billion in CMBS loans were originated prior to 2004.
(4) Projections per PPR CompassFLEX credit model on INTEX. Modeled with loan maturity extension and prepayment triggers enabled in a base scenario with conservative refinance underwriting parameters.
(5) See Client Updates “CMBS Bond Losses to Ramp Up,” dated March 29, 2012, and “Drawn-Out Liquidations,” dated Aug. 12, 2013.
(6) In 2010, PPR projected CMBS conduit loan losses to reach $60 billion under lenient refi conditions, on top of roughly $10 billion in losses already incurred. See Client Update “Impact of Extensions and Refi Terms on Losses,” Sept. 1, 2010.
John O'Callahan is a capital markets strategist for CoStar Group.
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