KBRA Releases Research – What Remains in Seasoned CRE CLOs?

NEW YORK--(BUSINESS WIRE)--KBRA releases research that analyzes currently outstanding commercial real estate (CRE) collateralized loan obligation (CLO) transactions issued in 2019, with the goal of understanding how collateral compositions have evolved over time in the wake of slowing loan prepayments and securitization note redemptions. This analysis also provides insight into potential future credit risk, or at least the challenges transactions may face as they age beyond their typical outstanding period. Deals issued between 2012 and 2018 were historically outstanding for 31 months on average, compared to 44 months (and counting) for the 2019 vintage transactions still outstanding. Only seven of the 29 2019 vintage CRE CLOs have paid off so far.

While all the deals are performing with an average delinquency rate of 1.8% and minimal existing note protection test failures, we expect that a number of them may remain outstanding for some time until new CRE CLO executions can become more economical in the capital markets, which would prompt securitization sponsors to redeem existing transactions. The current collateral composition of the CRE CLOs also suggests that high inflation, interest rates, and economic concerns are weighing on business plans and leading to loan extensions. These factors enable observation of transaction and collateral performance for a longer period, and they exist outside of the Goldilocks rate environment that has characterized much of the CRE CLO sector’s history over the past 10 years. That said, there have been a few transactions that have recently redeemed despite the lull in CRE CLO transaction issuance, and we expect more CRE CLO managers may wind down transactions utilizing warehouse lines. However, the fact that the 2019 vintage is 13 months more seasoned, on average, than prior vintages suggests that a number of transactions will remain outstanding far longer than usual in the sector.

Summary of Findings

KBRA’s analysis pointed to higher levels of credit risk on the horizon due to the following factors:

• The outstanding 2019 vintage transactions that did not pay off had a lower concentration of multifamily and higher concentration of office (38.5% and 27.7%, respectively) at issuance compared to those that paid off (54%, 17.9%).
• Among the outstanding transactions, the concentration of office properties has increased meaningfully to 56.4% from 36.4% for lightly managed transactions as a result of the slow rate of office payoffs.
• In managed transactions, over two-thirds of office loans have been in the pool since issuance. This suggests that many of the properties have not been able to fully execute their plans after nearly four years.
• Multifamily, which saw large gains in rents and valuation shortly after the pandemic, may also be experiencing difficulty in meeting business plans or refinancing at the current higher rates. In managed deals, the mix of multifamily has not changed meaningfully from issuance (40.4% of current balance versus 38.1% at issuance). This primarily stems from acquisition of new multifamily loans over the transaction reinvestment period. However, since these new reinvestment assets were likely originated in 2020 or 2021, the subsequent increase in interest rates and slowing rent growth may make it more difficult to execute a business plan and refinance.

Despite the increased risk, the transactions generally benefit from increased credit enhancement levels owing to loan payoffs that have occurred to date, particularly for securities with high investment-grade ratings. Only five of the deals had the most senior A notes outstanding as of March 2023, with credit enhancement of the remaining outstanding A notes ranging from 58.2% to 98.1%.

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About KBRA

KBRA is a full-service credit rating agency registered in the U.S., the EU, and the UK, and is designated to provide structured finance ratings in Canada. KBRA’s ratings can be used by investors for regulatory capital purposes in multiple jurisdictions.