One year later, commercial mortgages are doing better than expected

The commercial mortgage collapse that had many distressed debt investors salivating at the start of the pandemic never materialized, as the government's rescue packages created unprecedented cooperation between lenders and borrowers. But certain property types still remain vulnerable and after the stimulus ends, could be ripe pickings, said DebtX CEO Kingsley Greenland.

In the early days of the shutdown, distressed debt investors were making pitches that promoted the likelihood of a commercial credit market collapse.

"Sure, a handful of new buyers and some re-entering from the sidelines were looking for high, above-market returns, but they were quickly disappointed," Greenland wrote. "Investor yields tightened, instead of loosened. Prices for distressed assets climbed in the face of looming credit distress."

This was because non-performing loan volume, while higher than in recent years, especially among hospitality and retail properties, remained near historic low levels.

Since last June, the commercial and multifamily late payment rate for mortgages of all investor types peaked at 6.4% in August before dropping to 5% for March, the Mortgage Bankers Association reported earlier this month.

Therefore the "surprising lack" of non-performing loan sales by lenders looking to clear those mortgages from their books created a supply-demand imbalance.

"Stimulus packages kept many businesses liquid, and banks found a benevolent regulatory environment that encouraged cooperation with borrowers," Greenland said. "Routine credit extensions with no adverse regulatory consequences — unheard of in prior financial crises — created a safe harbor for distressed loans."

Despite the lack of non-performing loan sales, the overall market was quite active in the past year; DebtX's volume was substantially higher than it was in the 12-month period before that, Greenland said.

"Sellers were looking to rebalance a loan portfolio based on changing market conditions, not dumping bad loans," Greenland continued. "They were optimizing their balance sheets on a risk-adjusted basis to move their institutions forward."

But there will still be some stress from non-performing commercial mortgages on the market for a little while longer.

"The clock is likely ticking for weakened office, retail and healthcare loans," Greenland said. "It will be interesting to see what transpires after the stimulus payments wash through the system."

Even with the recent improvement, the latest data from the commercial mortgage-backed securities tracked by Fitch Ratings shows hotel delinquencies at 16.72% in March down a scant 8 basis points from February.

However retail properties saw strong improvement, down more than a full percentage point, to 9.01% in March from 10.08% in February. That was driven by a large drop in retail mall property delinquencies, to 14.39% for March from February's 17.48%.