There is quite a lot of pain ahead for any institution with exposure to commercial real estate, as a various recent (and not-so-recent) reports make clear. As the FT noted in March:
The commercial property market is under pressure across the US, where vacancies are expected to reach 14.7 per cent this quarter and approach 18 per cent by the end of the year, according to the National Association of Realtors. Property owners cannot refinance or pay for new construction and delinquencies, although still small, have jumped in the past few months.
And here’s the Fed commenting on commercial real estate in the April beige book (emphasis ours):
investment activity is being hampered by worsening credit availability “that is very close to a complete absence of lenders.” As you would expect, investors in CMBS – securities which bundled portfolios of mortgages on commercial properties – are also going to be affected, both directly (by rising defaults on those loans) and indirectly (by rating agency downgrades of those securities).
On the latter point, Standard & Poor’s on Tuesday issued a “request for comment” on its rating methodology for US CMBS, which it is in the process of tweaking. Included in that document was the following paragraph (emphasis ours):
It is likely that the proposed changes, which represent a significant change to the criteria for rating high investment-grade classes, will prompt a considerable amount of downgrades in recently issued (2005-2008 vintage) CMBS. Classes up through the most senior tranches of outstanding deals (so-called “A4s,” “dupers,” or “super-duper seniors”) are likely to be affected.
Our preliminary findings indicate that approximately 25%, 60%, and 90% of the most senior tranches (by count) within the 2005, 2006, and 2007 vintages, respectively, may be downgraded. We believe these transactions are characterized by increasingly more aggressive underwriting than prior vintages. Furthermore, recent vintage CMBS, particularly those issued since 2006, were originated during a time of peak rents and values, and as such, may be more affected by the proposed rental declines discussed in this RFC. We are currently evaluating the impact of the potential criteria changes on conduit/fusion CMBS transactions from all vintages. Once we evaluate the potential impact on existing ratings, we expect to issue a follow-up publication to this RFC.
In a word, ouch.
Just last month, S&P put $100bn of CMBS on watch for possible downgrade. This update is a warning that “possible” really means “extremely likely, and more to come.”
Small wonder, then, that the Fed recently expanded the TALF program to include “legacy” CMBS assets.
Related links:
S&P’s CMBS stress test – FT Alphaville
Questions raised over property vehicles – FT