KBRA Releases Research – CRE CLO Distress and Loan Modification Rates Soar
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NEW YORK ~ New York - According to a recent report released by credit rating agency KBRA, the distress and loan modification rates for commercial real estate (CRE) collateralized loan obligations (CLOs) have shown a clear deterioration. The review, which focused on CRE CLO loans originated prior to 2023, revealed that the distressed loan rate has increased nearly four times from the end of 2022 to 5.4%. Additionally, the rate of loan modifications has also seen a significant increase of over 100% during the same period, reaching 16.7%.

At the end of 2022, the distress rate for these loans was relatively low at 1.4%, while the percentage of loan modifications was at 7.9%. However, with multifamily properties making up about 70% of the aggregate outstanding loan balance, this sector performed better with a distress rate of 4.3% and a modification rate of 12.7%. On the other hand, office properties, which represent about 13.3% of the population, had a higher distress rate of 12.3% and a modification rate of 35.4%.

The decline in CRE CLO loan performance can be attributed to various factors such as higher interest rates and challenged business plans, particularly in multifamily and office properties which make up over 80% of outstanding loans. The multifamily sector has been experiencing slowing or negative rent growth and higher operating costs while the office sector continues to face demand shifts leading to weak leasing activity.

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As a result, several deals in recent months have failed their interest coverage and overcollateralization note protection tests as loans became delinquent.

In their report, KBRA assessed the performance of all KBRA-rated and non-KBRA rated CRE CLOs with a focus on loans originated in 2022 and prior totaling $78 billion in unpaid principal balance as of December 2023.

The report also highlighted key statistics such as multifamily properties making up 69.9% of the principal balance and 68.8% of the loan count, with office properties at a distant second with 13.3% and 11.4%, respectively.

The overall distress rate for these loans was found to be 5.4% by balance and 5.1% by loan count, with multifamily having a lower distress rate of 4.3% for both balance and loan count while office had a higher distress rate of 12.3% and 12.7%, respectively.

Similarly, the overall modification rate was at 16.7% by balance and 13.7% by loan count, with multifamily having a modification rate of 12.7% and 11.7%, respectively, while office had a significantly higher modification rate of 35.4% and 27.4%.

The report also noted that the worst-performing cohort of outstanding loans were those originated in or before 2020, with a distress rate of 11.9% and a modification rate of 51.1%. However, the outstanding CRE CLO transactions from years prior have paid down by almost half (48.9%), which has increased subordination levels for all remaining loans in these deals.

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Despite the worsening performance of CRE CLO loans, ratings have remained stable due to factors such as pay-downs on older-vintage transactions, subordination levels that account for the additional risk associated with non-stabilized collateral, and structural features of the transactions.

However, if these trends continue to deteriorate without improvement, KBRA expects to see negative rating drift in this sector, particularly on the subordinate part of the capital structure.

To view the full report, click here.

KBRA is a full-service credit rating agency registered in multiple jurisdictions including the U.S., EU, and UK. Their ratings can be used by investors for regulatory capital purposes.

For more information, please contact:

Cammy Wan, Senior Analyst, CMBS Ratings Surveillance

+1 646-731-3327

cammy.wan@kbra.com

Roy Chun, Senior Managing Director, CMBS Ratings Surveillance

+1 646-731-2376

roy.chun@kbra.com

Business Development Contact:

Dan Stallone, Senior Director

+1 646-731-1308

daniel.stallone@kbra.com
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