Further Evidence That Securitized Small-Balance Loans Outperform
April 10, 2012
With help from CMBS analytics specialist Trepp LLC, we’ve reported occasionally on the performance of small-balance commercial mortgages securitized through Wall Street, relative to larger-balance conduit loans. The most noteworthy trend for small-balance specialists has been that financial distress among $5 million-and-under mortgages is now decidedly lower than with larger loans – with the gap clearly widening over the past year-and-a-half.
As we exclusively reported a couple months back, Trepp’s data indicates larger conduit loans were twice as likely to be in special servicing – 13.24 percent (on a principal-balance basis) with $5 million-plus loans, compared to 6.46 percent for the small-balance set.
Now comes further evidence documenting the stronger health of the small-balance space – and perhaps likewise the secondary and tertiary markets that are home to so many securitized loans secured by smallish collateral.
New analyses from Nomura Securities and Wells Fargo Securities suggest the general collective health of smaller securitized mortgages continues to improve more rapidly than is the case with larger loans – and that distress among smaller mortgages tends to get resolved more quickly as well.
One upshot is that small-balance borrowers may be in better position to tap Wall Street for refinancing amid the coming flood of leverage-challenged mortgage maturities.
Ernst & Young’s latest Real Estate Nonperforming Loan Investor Survey cautions that as much as one-third of the potential $1 trillion in commercial mortgages maturing over the coming half-decade might not get refinanced in full. But issues appear to have migrated disproportionately to larger-balance credits – as it seems that ever day or two comes news of another high-profile property getting in trouble.
That’s indeed the case, as Fitch Ratings reports that an average of roughly 20 more conduit loans carrying $20 million-plus balances have been transferred into special servicing each month over the past couple of quarters. Even as the overall CMBS delinquency rate has been inching downward for at least four months running, borrowers on the hook for several nine-figure conduit loans have made headlines just in the past couple-three weeks (L.A.’s Two California Plaza, Chitown’s Hancock Center).
Not that the small-balance space doesn’t have plenty of its own issues – it just seems to be more on the mend, as the Wells Fargo and Nomura research suggests. We’ll also point out here that both Nomura and Wells Fargo define small-balance as loans with original principal amounts of $10 million or less – rather than the $5 million threshold seen with many analyses (including in most cases SmallBalance.com and its parent Boxwood Means).
However, the stronger performance is by no means absolute. Both analyses found that when small-balance loans sour, the average level of loss CMBS bondholders suffer tends to be at least slightly higher than with larger loans. A likely explanation: special servicers and their bondholder clients often opt to simply take whatever they can get immediately for distressed small-balance loans, rather than investing resources into restructuring efforts as is more often the case with jumbo-sized loans.
Near-term illustration: The Auction.com team is aiming to dispose of another nearly $1 billion in mostly small-balance non-performing notes and small-cap commercial properties via three regional online auctions scheduled from Apr. 2 to Apr. 19 alone.
As for the particulars, Nomura’s analysis indicates current distress levels among smaller-balance apartment and retail mortgages securitized during the peak origination years (2005-08) are clearly lower than among their larger-loan counterparts. The exception is the office sector. But New York-based strategists Lea Overby and Steven Romasko also point out that office transactions account for only 11 percent (by dollar balance) of the small-balance loans among the studied loan vintages – with retail and multifamily each representing about 27 percent.
Nomura reports that securitized commercial mortgages with balances of $10 million or less have by many measures tended to perform better over time than conduit loans in the $10 million to $50 million range in particular. While the smaller-balance category generally under-performed larger loans during the initial shock of the Great Recession, they’re experiencing fewer issues now that the economy and property markets are stabilizing.
Indeed while overall delinquencies for the loan vintages of the study period are still rising – with the $25 million-and-up category dragging others along – delinquencies within the $10 million-and-under subset peaked at about 9 percent a year ago. They have since declined further to 8.4 percent. Delinquencies in the $10 million-to-$25 million range peaked about the same time – but remain 264 basis points higher.
And smaller-balance delinquency rates today are consistently lower than higher-balance rates among pretty much all the vintages in Nomura’s study period – and typically by at least 100 basis points.
The Nomura analysts also point out that smaller-balance collateral is more likely located in secondary and tertiary markets than larger-balance counterparts. The implication is that smaller markets, like smaller conduit loans, have seen less liberal underwriting practices – including less reliance on “pro forma” expectations and less allowance of interest-only periods.
Meanwhile the Wells Fargo research team headed by senior analyst Marielle Jan de Beur concludes that distressed smaller-balance conduit loans, as a group, tend to get resolved more quickly than larger loans.
As of Feb. 1 roughly one-third ($25.6 billion) of the $77.5 billion of CMBS loans in special servicing had been there for two years or more. But with the $10-million-and-under subset, less than one-fourth of the loans in special servicing have held that status for 24 or more months.
Also, 30 percent more small-balance loans exited special servicing (through restructurings, dispositions or other resolutions) than entered special servicing over the 12-month period of the Wells Fargo study. That’s clearly more fluid than the overall outflow-to-inflow margin of 23 percent.
Wells Fargo also reports that the stagnant loans are weighted heavily in the $10-million-to-$50-million category. Loans in that size range account for 32 percent of all loans (by balance) in special servicing – but 40 percent of those that have been there for 24 months or more.
On a more disturbing note, that overall ratio of “stale” loans in special servicing was actually a bit higher than the ratio calculated 12 months earlier. But as the Wells Fargo team relates, that’s primarily because so many large loans remain in special servicing.
The better news: the overall special servicing portfolio declined to that $77.5 billion figure from $83.7 billion a year earlier.
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