STRUCTURED WEEKLY: Heavy Bond Sales Mask Hotel, Retail Pain

(Bloomberg) -- Sales of new bonds backed by commercial real estate are booming to levels not seen in years even as hotels and malls face a long slog to recovery.

Loan delinquencies will remain “disproportionately high” for hotels and some retail properties underlying commercial mortgage-backed securities, according to Moody's Investors Service. In a seeming disconnect, Wall Street has pumped out $66.2 billion of debt backed by properties including those troubled sectors, according to data compiled by Bloomberg, the most in at least five years.

The securities are attractive to investors not just because of their relatively high yields, but also because they tend to be backed by stronger properties that are likely to perform well over the next few years. The bonds also have extra protections for investors built in. But investors looking at real estate bonds need to choose carefully, given the pressures on the space now, especially in hotels, according to analysts.

“Hotel loans will have an outsized share of CMBS delinquencies, driven by the slow recovery of the meeting and group and international-demand segments for lodging,” Moody's analysts led by Christopher Bergman wrote in a Wednesday report. “While lodging demand will continue to improve as the pandemic's stranglehold on travel eases, the asset class will remain stressed across the nation, with hotel delinquency rates more likely to rise before they make major improvement.”

Hotel loans account for over 22% of delinquencies in CMBS within the 25 largest metropolitan statistical areas, Moody's said. Late-pay rates for the New York metropolitan area stand at 31.2%, while delinquencies in the Chicago metro region hit 36.8%. In some good news for CMBS investors, though, hotels back just 6.7% of the private-label market, the ratings company said.

Last week a Blackstone Group Inc. and Starwood Capital Group joint venture financed its acquisition of Extended Stay America Inc. through a $4.65 billion sale of CMBS. It was one of the largest single-loan deals in a decade.

Retail Woes

Retail delinquency rates will persist as well, Moody's said, reflecting trends accelerated by the pandemic. A disproportionate share of delinquencies will continue to stem from regional malls, certain types of suburban centers and expensive urban street retail.

“Regional mall loans account for nearly three times more delinquencies than their share of CMBS, with two large markets – Orange County and Tampa – having mall delinquency rates exceeding 50%,” the Moody's analysts wrote.

Additionally, appraised values for some regional malls have plunged by almost two-thirds since they issued loans that were packaged into CMBS, according to a recent report from Fitch Ratings. The ratings company found a 62% drop in appraisal values for a set of 54 properties that it examined.

A Twist

Sales of so-called single-asset, single-borrower (SASB) CMBS and commercial real estate CLOs account for nearly 80% of this year's volume. That's a change from typical patterns, when bonds stuffed with multiple properties and borrowers have dominated volume. Part of the appeal for SASB securities is that they are often floating rate, giving investors some protection against inflation.

There were approximately $30 billion of SASB CMBS sold in the first half of 2021, $20 billion of CRE CLOs, and about $15 billion in CMBS conduits, according to data compiled by Bloomberg. This year's $66.2 billion of sales is about 96% higher versus the same period last year and compares to roughly $47.8 billion in 2019, according to data compiled by Bloomberg.

Relative Value: CMBS

Bank of America Corp. analysts are staying underweight last-cash-flow (LCF) AAA CMBS conduit bonds, and are neutral on the mezzanine part of the stack, according to a recent research note
They remain overweight on AAA floating-rate SASB CMBS and CRE CLOs, but underweight on guaranteed agency CMBS and neutral on risk-transfer paper
If the Federal Reserve begins tapering its QE purchases earlier than expected, they may start hiking interest rates, which will affect corporates
“To the extent corporate bond spreads soften, we could reasonably expect LCF AAA CMBS conduit bond spreads to soften as well,” the analysts said

Quotable

“This is the golden era of structured products,” Tricia Hazelwood, managing director and international head of securitized products at Mitsubishi UFJ Financial Group Inc., said in an interview this week, referring to the post-Covid era. “The performance of these assets has proven to be very, very strong, and we're at all-time lows in defaults and delinquencies across the board in asset-backed securities. Moreover, this is a time of innovation, with new types of non-traditional, esoteric deals getting done in different securitized sectors.”