Retail Sees High CMBS Default Rates

Mortgage Daily reported this week that the rate of late payments on securitized commercial mortgage backed securities (CMBS) funded loans rose yet again. The record number of balloon payments coming do this year means defaults will likely continue throughout the year. In fact, the fear of a major correction in the retail sector may make the situation worse.


Most CMBS secured loans are based on a 10 year interest only note. Many of those loans were written at the height of the real estate market in 20007. One year later, the real estate market collapsed. Even after 10 years, some properties have not regained their pre-crash values. This is especially true with retail malls.


A record number of stores have announced closures this year. Topping that list is JC Penney, K-Mart and Macy’s. Teetering on the brink of total collapse is Sears. In many malls, these stores are considered anchor tenants. If one of these stores closes, the value of the mall plummets absent an immediate replacement.


Lose an anchor tenant and the remaining tenants will either look for a new location or demand big rent concessions. Mall owners may be forced to make expensive renovations to bring in new tenants.


During the first quarter of 2017, Credit Suisse says there have been 2,880 major store closures. During the same time last year, just 1153 stores shuttered their doors. Those numbers are expected to get worse as the year progresses. Credit Suisse anticipates 8,660 closures this year. Only 6,220 stores closed during the height of the recession in 2008.


Commercial properties are generally only as good as their tenants. With so many retail stores contemplating closure or bankruptcy, the value of retail malls is in jeopardy. Lenders are scared that a mall could quickly fail if an anchor tenant leaves


And the timing of the retail bubble couldn’t be worse!


Many investors simply believe that if the property generates sufficient cash flow, their CMBS loan will be automatically renewed. Unfortunately, that assumption is wrong. Let’s examine this in more detail.


CMBS Trusts Are Not Banks


A CMBS trust is not a bank. Although investors obtained their loan through a bank, that loan was spun off into a trust. The trust has no office, no employees, no one to answer the phone and no ability to make loans. It exists on paper only.


The trust is a group of institutional investors who packaged and purchased a pool of commercial mortgages. Once the pool is formed, the trust collects the payments and hopes to show a profit when the trust ends. They don’t make loans or refinance existing ones.


As these 10 year notes become due, some investors are caught unprepared for refinancing. They think that the trust will just extend the note for another 10 years.


Positive Cash Flow Only Goes So Far


The other mistaken assumption made by investors concerns cash flow. For homeowners, it is assumed that if you make timely payments on your home equity loan, the loan will continue to be renewed. Not so in the CMBS world.


Commercial lenders want to see both positive cash flow and significant cash reserves. Simply being able to pay your bills isn’t enough.  If you own a shopping center, would-be lenders are going to want to see significant equity and reserves.


Because many lenders worry about massive store closures, they worry that the value of a shopping center could plummet overnight.  That means these lenders also want to see enough cash in case the cash flow from shopping centers slows significantly or expensive renovations need to be made to attract new tenants.


Next Steps for Shopping Center Investors


If you own a CMBS financed shopping center don’t despair. First, know that planning should begin in earnest at least 1 year before your note comes due. Don’t wait. Even if you have great cash flow, don’t be lulled into a false sense of security. It can easily take a year to arrange new financing.


Second, know that the trust that owns your note probably can’t help you refinance.

Not sure what to do? Call us. Our CMBS lawyers can help you negotiate extensions, refinance and if necessary, defend you if you find yourself in default.


For more information, contact attorney Chris Katers at [hidden email] or by phone at (414) 777-0778. The author of this post, attorney Brian Mahany, can be reached [hidden email]. You can also find more information on our Commercial Backed Securities CMBS information page.


MahanyLaw and Judge, Lang Katers – America’s CMBS Lawyers – “Representing Borrowers and Investors, Never Lenders”

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