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Problems are brewing in the Commercial Mortgage Bond Securities (CMBS) market. For an overview on the residential housing market, see my article published on Apr. 19, Bubblicious Housing – Having the Brains to Walk When It’s Time to Walk.

The mortgage loans securitized into CMBS can include loans made to hotels, manufacturing companies, multi-family apartment buildings, office buildings, and shopping malls. According to Moody’s Investors Services, the $1.2 trillion CMBS market is beginning to show similar issues that led up to the Mortgage-Backed Securities (MBS) market blowout during the last financial crisis. The CMBS are swollen with many low-quality loans, and during 1Q18, 75% of the loans are said to be interest-only mortgages, a 2006-2007 déjà vu.

Interest-only loans are much riskier because a borrower does not pay any principal on the loan for a set period at the beginning of the mortgage term. When interest payments come due in the future, payments become much larger.

The following charts are courtesy of TCW Commercial Mortgage Market Monitor Report, April 2018.

Delinquency Percentage…

Watch List Exposure Percentage…

Watch List and Special Servicing Summary…

All of the data represented in the above charts has been on the rise since early 2012, and the amount of interest-only loans in the CMBS is a closely watched trendsetter because those loans are more likely to default, with a larger loss to lenders.

The following chart is from Bloomberg, Jun. 2018…

It is interesting to note that in May of 2007, Moody’s said to the NYT that “underwriting in commercial mortgages has gotten so frothy that we have to take a stand… The industry was heading to Niagara Falls.” In Jan. 2015, they complained about similar issues to the WSJ, with a headline that read “Moody’s Report Criticizes Rivals for Easy Ratings on CMBS – Says Rivals Give Investment-Grade Ratings to Securities That Don’t Deserve Them.” In Jun. 2018, Moody’s is quoted again as saying “Underwriters are not taking steps to offset rising risks… a significant negative credit trend, as well as an important warning sign of deteriorating underwriting standards.”

 My next question was which sector in the CMBS market is telegraphing to be the worst performer. The Minnesota Real Estate Journal had a write-up two months ago answering that question. Office buildings could be a canary in the coal mine as the workforce shifts further away from traditional corporate infrastructure and the fourth industrial revolution takes hold.

Is CMBS Underwriting Getting Loose?… “There is some concern regarding the increase of office assets in CMBS transactions, as it also signals a higher risk of potential deterioration in loan quality down the road, says Natalka Chevance, director in the CMBS group at S&P. ‘Historically, suburban office buildings have had higher default and loss rates relative to CBD office,’ Chevance notes. In addition, Moody’s research shows that most companies (roughly 80 percent) that occupy single-tenant office properties today are not investment grade. That raises the risk of the tenant having less cash flow stability over the term of the lease.” – MREJ, Mar. 2018

The following chart is also from the TCW report, and it clearly shows a red spike occurring in the office space sector…

 

What did Sam Zell have to say about the commercial real estate market in late 2017?  If the Bloomberg interview with Zell does not load on this page, go here, it’s a must see.

The next data point to lasso is a pure CMBS sector ETF.

Here we have BlackRock’s iShares CMBS ETF monthly chart as of the Jun. 6, 2018 close…

The price has taken out its all-time low of $49.70, printed during Jun. 2012, and put in a new low of $49.27 in May 2018. The trend downward remains below all Exponential Moving Averages (EMA), and not shown is a 50/200 EMA Death Cross on the weekly chart that took place during Nov. 2017. Volume is zip. It’s not looking great for the CMBS market, and this chart is Bearish.

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