Trouble Ahead for Maturing CMBS Loans
- Jun 15, 2016
Rating agencies have begun flashing yellow lights with regard to the next wave of maturing CMBS loans, those coming due in the second half of 2016 through 2017. The lion’s share of these loans were originated at the peak of the market in 2006 and 2007, before the Great Recession, and many maturing CMBS loans are overleveraged by today’s underwriting standards.
The lender landscape has changed dramatically, and borrowers who are not in the market regularly will be surprised as they face a much more challenging environment. Gone are the days of high-leverage loans underwritten on trended rents and aggressive valuations. Loans that were once closed in 30 to 45 days now undergo painstaking scrutiny and can take 90 days or more to close.
CMBS originators remain active, but many of the familiar names from 10 years ago are long gone. The market correction earlier this year resulted in a number of CMBS originators closing shop. Banks are active, but new regulations have curtailed their demand. A number of new players such as REITs and private loan funds have stepped in to fill the gap, offering more attractive terms but in many cases charging higher rates.
CMBS Borrowers Face Risks
Given the longer transaction lead times, failing to plan well ahead of the loan maturity date will cause major problems for CMBS borrowers. The window for prepayment without penalty is typically only three to six months prior to the maturity date. Failing to repay the loan by the maturity date will trigger a loan default, meaning that late fees (typically 5 percent) will be charged on the entire loan amount. In addition, loan administration will be transferred to a special servicer, who will charge higher servicing fees, take control of the rents and potentially appoint a receiver to oversee the property. The risk of foreclosure by the CMBS special servicer is especially high for defaulted loans under $20 million, which is significant since the majority of CMBS loans are in the $5 million to $10 million range.
An overleveraged maturing CMBS loan can be a huge headache for the borrower. Loan maturity date extensions can be negotiated in some cases, typically subject to a cash contribution, but this may not be an option for all borrowers. If an extension isn’t available, it’s necessary to infuse additional equity or sell the property to repay the loan. For larger loans on good-quality properties, the equity gap between a new first mortgage and the maturing CMBS loan amount may be funded by third-party mezzanine debt or preferred equity.
If the loan is underwater, the borrower faces an even tougher road. The borrower can pay the shortfall out of pocket, but that might not be possible. Unfortunately, for defaulted CMBS loans under $20 million, the options are very limited—special servicers are more inclined to simply foreclose. Borrowers with larger loans, however, may have an opportunity to restructure and extend their CMBS loan, provided that they can bring significant cash to the table. Such solutions are highly complex and difficult to achieve, but they are possible.
Borrowers with maturing loans that are not overleveraged should fare well if they initiate the refinancing process well ahead of the due date. But borrowers with maturing loans that are overleveraged or underwater are well advised to seek the advice of professional advisors with expertise in both negotiating CMBS loan modifications with special servicers and sourcing third-party “rescue” capital if needed.