(Bloomberg) --Commercial real estate loan modifications soared in the second quarter as more borrowers sought time to repay debt in a challenging property market.
More than $4 billion of collateralized loan obligations on commercial real estate received a modification in the three-month period, compared with about $1 billion in the first quarter, DBRS Morningstar reported.
Modifications — such as prolonging a maturity in exchange for a partial principal payment — can give landlords breathing room while they await a recovery. Extending is a practical option at a time when lenders have reined in originations for real estate, and opportunities for building owners to profit from a sale are diminishing as values fall.
While the jump in modifications reflects a lack of financing options for landlords, it's premature to call it a sign of trouble, according to Stephen Koehler, who oversees commercial real estate CLOs at DBRS Morningstar.
"It's kind of a 'Keep your eyes on this. Don't forget about this,' but not like a siren going off," Koehler said in an interview.
Commercial real estate CLOs are typically floating-rate loans for buildings that are undergoing renovations or being leased up after construction. Borrowers' payments have soared since the Federal Reserve began hiking interest rates last year.
At the end of the second quarter, the share of outstanding loans with modified terms increased to 11.8% of CLOs from 6.5% in the first quarter, DBRS Morningstar said.
About 65% of outstanding property CLOs are on apartment buildings, the Commercial Real Estate Finance Council reported. Much of that debt is coming up for renewal as rents are declining in Sun Belt markets such as Phoenix and Austin, where sales and development soared during the pandemic era of low interest rates.
CLO modifications rose faster than the delinquency rate, which climbed to 3.14% at the end of June from 2.99% at the end of March, according to DBRS Morningstar. The share of loans in special servicing dropped to 0.66% from 0.74%.
"I wouldn't use the term 'extend and pretend' yet," Koehler said, referring to the practice of lengthening maturities on properties with plunging values. "There's not a big uptick in delinquencies and these aren't distressed assets."
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