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 $16.04 billion for all of 2010, significantly less than the average annual securitization volume of $77.5 billion for the period 1995 to 2009. However, the CMBS market improved over the past six months and multiple industry research reports are estimating as much as $40B of new CMBS issuance by year end 2011. This will mostly be absorbed by the top CMBS servicers. Other commercial MSRs available in the market were from Freddie Mac Capital Market Executions, which had a combined unpaid principal balance of approximately $6.4 billion in 2010 and $4.3 billion as of April 2011. MSR transactions in the secondary market were very weak in the first quarter with an estimated volume of approximately $0.5 billion in unpaid principal balance sold.
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
Market values for Commercial MSRs were strong for FHLMC CME execution, but weaker for Agency portfolios. Some of this weakness on the Agency side can be attributed to higher prepayment speeds. However, earnings rates on replacement reserves and tax and insurance escrow balances have continued at lower levels for more than three years now, and all commercial servicers are feeling the “economic” impact of that loss of interest income. If rates continue to remain flat or even decrease, MIAC believes that servicing buyers will drop their earning rate assumptions from their present level, thereby lowering market values. On the default side, we do not believe there will be any material increase from current levels in the Agency sector. However, the CMBS primary servicing sector may see default rates continue to rise, thereby increasing involuntary prepayments and decreasing market value. On a positive note, recent commercial mortgage company acquisitions by non banks may yield some new commercial MSR buyers in the near term and strengthen the buy side.
Daniel Thomas
Managing Director, Client Solutions Group