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Dan Thomas
Managing Director,
Client Solutions Group
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Commercial Servicing Market Update
Overview
The commercial real estate market delinquency rates have still been rising, albeit at a more moderate pace from the first half of the year. Monthly CMBS delinquency rates have slowly increased from 7.70% in June 2010 to 7.93% in Aug 2010, with the newest delinquency projections from Realpoint of between 9-10% by December 2010. CMBS loans moving to special servicing also have increased dramatically from roughly $67 billion in December 2009 to $91 billion in August 2010. Delinquencies for the other investor groups have not been any where near as severe as the CMBS investor group. At June-end, the 60+ delinquency rates were the following: Life Companies (.29%), Fannie Mae (.80%), Freddie Mac (.28%) and Bank & Thrifts (4.26%). These modest levels are at their highest level in over a decade but will not have much, if any, impact on the value of Agency MSRs. The CMBS delinquency and default levels, however, have had a real impact on values through involuntary prepayments (defaults) and resulting loss of servicing revenue.
Supply and Recent Transactions
Transaction volume in the commercial servicing market for the first three quarters of 2010 continues to be still extremely light in relative terms, mostly due to the lack of new CMBS issuance. The new issuance CMBS servicing supply was only $4.8 billion as of September-end with another $6.2 billion expected to close before year-end. This is a far cry from the CMBS securitization peak volume of $230 billion in 2007 and the average annual securitization volume of $77.5 billion for the period of 1995-2009. As discussed in our July Perspectives Issue, new commercial MSRs have come to the market through the Freddie Mac Capital Market Executions, which had a combined unpaid principal balance of approximately $8.7 billion, with $6.1 billion sold in 2010. One notable servicing transaction that was completed in the third quarter of this year was the sale of CW Financial Services and its servicing unit CWCapital to affiliates of Fortress Investment Group, LLC. CWCapital is both a Primary and Special Servicer with a portfolio of approximately $11 billion of primary servicing and $160 billion of Special – $11 billion of which is currently actively managed.
Market Values
Market demand remains strong and has been a good support for market values. This strength has been mostly driven by the lack of commercial servicing supply available to market participants. Most servicers are losing servicing income through involuntary prepayments (defaults) particularly in the CMBS sector and the lower origination volume has impaired servicers’ ability to replace lost loans with new servicing. This has been the main reason why demand remains consistently high.
More negatively, the continued lower interest rate environment has reduced the interest income component of commercial servicing. The prolonged period of lower interest rates have slowly been creeping into the bidding assumptions of the major buyers of commercial servicing and has been hurting values. Portfolios with a shorter average life are currently being priced more conservatively with lower earnings rates than portfolios with a longer average life. This is directly related to the current yield curve and the interest rate projections for the intermediate and long term.
The Outlook
Market values for Commercial MSRs should continue at current levels, provided interest rates remain stable and do not go significantly lower. On the default side, we do not believe any increase from current levels in the Agency sector will have a material effect on market values, unless of course default rates increase by 300-400% from their current levels. The one area that may be at risk is the CMBS primary servicing sector. If CMBS default rates continue to escalate at the same pace as 2010, that will significantly increase involuntary prepayments, reducing the servicing income stream associated with those loans. The market will certainly be watching the CMBS default levels very closely over the next several quarters.
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