Downgrades in U.S. commercial mortgages signal distress | Insights | Bloomberg Professional Services

Background

Downgrades of U.S. commercial mortgage-backed securities (CMBS) surpassed 2022’s total already in 2023. Rating companies cited rising vacancies, surging loan-to-value ratios, deteriorating property recovery values and higher borrowing costs when making these downgrades.

Non-agency CMBS issuance is still down 68% this year, even after a second-quarter pickup, raising doubts over the refinancing of office and mall debt. Meanwhile, warning signs continue to emerge in the U.S. commercial real estate market, with distressed assets up 10% in the first quarter, according to a MSCI Real Assets report.

The issue

Moody’s U.S. CMBS downgrades reached a two-year high of 252 in March, with 284 of this year’s 759 downgrades involving investment-grade CMBS. So far in 2023, the Bloomberg CMBS Investment Grade Total Return Index has returned 1.6% after declining 11% last year.

Other investors remain concerned that the commercial real estate troubles will get worse, with the impact spreading to regional banks. About 700 U.S. banks fail to meet ‌Federal Deposit Insurance Corp. guidance from 2006 regarding commercial property loan concentration and risk management, twice as many as two years ago. That may result in greater supervisory scrutiny, including higher required capital levels.

CMBS issues are usually structured as multiple tranches, with investors in the highest-rated securities paid first in the event of defaults in underlying loans. Delinquent office loans at a five-year high may prompt investors to avoid the riskiest types of CMBS.

Spread tightening may be “tough to sustain” as “property-asset challenges include vacancies, nervous lenders, rising delinquencies, steep disposal discounts, inflation and higher yields,” wrote Tolu Alamutu, a Bloomberg senior credit analyst.

Tracking

Use Bloomberg’s LDES tool to monitor CMBS securities, portfolios or indexes and the health of underlying assets.

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