Overview - Q4 2011
The commercial real estate market continues to struggle with significant amount of underperforming assets in most of the major property types. Delinquency rates rose during the second half of 2010, albeit at a more moderate pace than the first half of the year. CMBS delinquency rates (30+ days and REO) have slowly increased from 8.95% at the end of Q4 to 9.18% at the end of Q1 2011. In its most recent projections, Realpoint expects CMBS delinquencies continue to rise above 9% in 2011. CMBS loans in Special Servicing at the end of April 2011 amount to approximately $88 billion, down from the trailing 12-month high of $91.4 billion in September 2010. Delinquencies for the other investor groups have not been anywhere near as severe as the CMBS investor group. At March end, the 60+ days and REO delinquency rates were the following: Life Companies (0.14%), Fannie Mae (0.64%), Freddie Mac (0.36%), and Bank & Thrifts (4.18%). These modest levels are slightly less than reported at September-end 2010. As discussed in previous MIAC Perspectives, delinquencies have had little or no impact on the value of Agency MSRs. However, CMBS delinquency and default levels continue to have an impact on values through involuntary prepayments (defaults) and the resulting loss of servicing revenue.
Commercial Servicing Supply
The overall volume of commercial servicing that was available for sale year-to-date has been extremely light, with the only real volume coming from new issuance CMBS. As previously reported, CMBS servicing supply was only $37.5 billion as of November 2011, with the vast majority of the volume going exclusively to the large CMBS servicers. The forecasts from multiple CMBS research reports are estimating between $40B – $45B of new CMBS issuance in 2012. This will mostly be absorbed by the top CMBS servicers.
Market Demand
Market demand continues to remain strong among the top commercial servicers, especially for CMBS loans. This strength has been mostly driven by the lack of commercial servicing supply available to market participants and involuntary prepayments. However, demand continues to be weak among the middle-tier and small commercial servicers. This lack of demand has created a very thin secondary commercial MSR market, one that is highly dependent on the participation of the mega servicers for liquidity and ultimately market value.
The Outlook for CMSRs in 2012
Market values for Commercial MSRs should be relatively flat in 2012. There are offsetting factors that will influence both the cost and revenue side of commercial servicing economics which include:
- Interest income on escrow and reserve balances have leveled off after a three- year period of declines due to a steep drop in the yield curve. Interest rates are not expected to increase dramatically from current levels in 2012 and should not impact market value.
- Low servicing replenishment rates at the mega-servicers will continue to be a driving factor in keeping the demand for CMSRs strong.
- Servicing costs have been rising over the past couple of years due to the increase of watch list loans, rising delinquencies and defaults, and slower workouts and liquidations.
- Prepayment rates are a bit of a wild card for 2012. In the CMBS sector, involuntary prepayments (defaults) will continue to decrease servicing income whereas the voluntary prepayments will likely be extremely slow due to the ongoing depressed market conditions in commercial securitizations. In the Agency sector, involuntary prepayments will again not be a noticeable factor in market values. However, voluntary prepayment rates for multifamily properties have been much faster than anticipated over the last 18 months due to the extremely low level of interest rates available for refinance. The question remains as to whether property dynamics and the overall economic climate remain flat or improve over the next year. Any improvement will allow more properties to enter the realm of potential refinance and that will hurt market values on existing commercial servicing portfolios.
There are some clouds on the horizon beyond 2012. Some volatility is to be expected as balloon maturity and default risk remains an issue for highly seasoned CMBS transactions as loans are unable to pay-off due to a combination of low DSCRs and/or high LTVs. The darkest cloud however is Basel III. Basel III capital limitations for MSRs may put pressure on several of the large Bank owned mortgage servicers to reduce their overall mortgage servicing holdings. Since the CMSR market is largely driven by the strong demand by the mega-servicers any reduction in that demand could have a dramatic long term effect on CMSR values.
Daniel Thomas
Managing Director, Client Solutions Group