Obstacles mount for passage of CMBS relief bill
A bipartisan congressional bill introduced last month that would benefit struggling CMBS borrowers through a new Treasury-backed lending facility has moved on to the House Financial Services Committee for consideration.
But passage could be an uphill battle, based on negative reaction to the measure. Even an influential pioneer in the commercial mortgage-backed securities market has bashed the measure as a bailout for deep-pocketed developers and investors that is “wrong, plain and simple.”
“CMBS borrowers are corporate entities or wealthy individuals who should have known better and who took risks they must now pay for,” Ethan Penner, co-founder and managing partner of New York-based Mosaic Real Estate Investors, wrote in an Aug. 6 online commentary on the website Medium. “These businesses should be allowed to fail.”
Penner, a former Nomura Securities financier who as “father of CMBS” helped develop the market for securitizing commercial real estate loans in the 1990s, voiced the kind of criticism that securitized credit analysts from Barclays had predicted shortly after the July 29 introduction of the HOPE (Helping Open Properties Endeavo”) Act.
“[D]espite the bipartisan support, we think that there are various obstacles for this bill to pass, the biggest of which is that it will likely be perceived as bailing out wealthy landlords,” according to a July 31 Barclays securitized credit research note.
The HOPE Act bill is co-sponsored by three lawmakers — Reps. Van Taylor, R-Texas, Al Lawson, D-Fla., and Andy Barr, R-Ky. — who have warned of a growing wave of delinquencies, foreclosures and further job losses in the hotel and retail industries if CMBS obligors cannot meet their debt service payments. CMBS delinquencies in May topped 10% for the first time in eight years, and borrowers have little flexibility through lenders or servicers to manage their sharp reduction in income due to coronavirus-related business shutdowns.
The bill would authorize the U.S. Treasury to purchase preferred equity investments in CMBS loans, using funds from the Coronavirus Aid, Relief and Economic Security (CARES) Act.
But while the legislators discuss the threat to CMBS borrowers' livelihoods, large investment firms will also be among the chief beneficiaries of the legislation. They include Tom Barrack’s Colony Capital (NYSE: CLNY) and Ashford Hospitality Trust Inc., according to Bloomberg News.
Barrack, Colony's executive chairman, was a vocal proponent of government-backed CMBS relief in late March at the onset of the coronavirus pandemic.(In May, Colony reportedly defaulted on $3.2 billion in loans among its portfolio of more than 150 hotel and healthcare properties.)
Meanwhile, the chief financial officer of Ashford Hospitality (NYSE: AHT), a hotel-centric real estate investment trust based in Dallas, said in an early August earnings conference call that he expected the bill to be "a huge help for us." As its valuation fell 80% this spring, AHT's search for new funds included being granted a $68 million loan from the Paycheck Protection Program intended for small businesses. AHT at first insisted it was keeping the money when its loan drew negative headlines in May, before agreeing to return the proceeds back to Treasury.
Under the HOPE Act, borrowers including REITS, private-equity developers and property-management firms would have access to the new Treasury facility, which would provide guaranteed bank financing (at 2.5% interest) for as much as 10% of the outstanding balance on a mortgage loan (some of which top $1 billion). The HOPE loans would only be available to borrowers whose properties have seen a 25% decline in property value since March 1, had a minimum 1.3x debt-to-service coverage ratio in 2019 (or in both 2017 and 2018), and not be in default.
Any borrower delinquency also must have occurred after March 1.
Supporters tout the HOPE Act as a means to stave off foreclosures of commercial real estate properties hard hit by the COVID-19 fallout, notably lodging and retail properties. Commercial borrowers have not only suffered falling revenues, but are unable to secure bridge or emergency financing under CMBS loan agreements prohibiting further debt obligations. Many hotel properties, for instance, have had to negotiate with lenders to fund debt payments from reserve funds typically used for property fixtures and maintenance, according to an Aug. 3 report from Moody's Analytics.
That is unsustainable, a Barclays CMBS strategist, Anuj Jain, said in an interview.
"Despite the [revenue] improvement since the lows in April, most hotels are still not able to break even or have positive cash flow, based on the recent earnings of lodging REITs," Jain said. "It is possible that the reserves are so high that you can continue to get through this, but others, I think you can justify the need of for some kind of relief."
Barclays estimated in its report that the HOPE Act would likely cover a vast majority of nonagency CMBS loan portfolios, which are dominated by hotel- and retail-industry loans, of which “almost all will satisfy” the one-fourth revenue-decline requirement.
The level of CRE loan delinquencies and special-servicing assignments across the board is mounting, particularly in lodging and retail. Research data from Trepp shows July’s CMBS special-servicing rate leaped to 9.49% from 8.28% in June. Within the lodging sector, special servicing rose to 24.3% of all loans in July, compared with 20.47% the previous month. For retail loans within CMBS portfolios, it rose to 16.04% last month from 14.24% in June.
The CMBS market thus far has largely not benefited from the trillions of dollars the Treasury Department and Federal Reserve have pumped into the economy. Bonds issued from CMBS transactions, for instance, have been excluded from the $100 billion Term Asset-Backed Securities Loan Facility (TALF) that provides discount financing for the AAA-rated notes of other structured-finance classes like auto, student and credit-card loans, as well as collateralized loan obligations.
In his commentary, Penner argues that CMBS borrowers should not be aided from taxpayer support in the first place. He notes CMBS loans often include lucrative cash-out payments for owners or to lever up high-profile acquisitions.
“Borrowing from the CMBS system became a forum for mostly the greedy and risk-loving, or the clueless, none of whom deserve a bailout,” Penner wrote. “Commercial real estate is a game for professionals and governmental aid ought to be reserved for segments of our society that are in real need.”
Barclays' report stated that not only might the bill draw the rancor of bailout opponents, subsidizing loans in some longstanding CRE trouble spots may not be sound investments for the government, such as shopping malls “which are experiencing a secular long-term decline.”
Barclays also noted that since “this bill is not part of the recently introduced HEROES [Health and Economic Recovery Omnibus Emergency Solutions] or HEALS [Health, Economic Assistance, Liability Protection, and Schools] Acts, it might not get much traction in the near term, unless it is added as a simple amendment to any broader relief deal that is finalized.”
Some have argued for expanding support to CMBS borrowers under the PPP and the Main Street Lending Program, as advocated by the Commercial Real Estate Finance Council, a trade group. Similarly, Sen. Mike Crapo, R-Ind., chairman of the Senate Banking Committee, has endorsed the expansion of Main Street program to address “the unique circumstances faced by commercial real estate, including securitized commercial mortgages.”
Barclays analysts, however, said a more workable solution would be to develop a relief program on smaller-balance CRE loans. They estimate up to 30% of loans that would be eligible for the proposed preferred equity facility have balances of less than $25 million.
But even those solutions would be a bridge too far, Penner argued.
"Capitalism works when our government can maintain discipline and does not intervene to rescue failures," Penner wrote. Masking over the CMBS market's "systemic weaknesses by rescuing borrowers with taxpayer capital, as the current legislative proposal recommends, would surely undermine the long-term of CMBS."
(Additional reporting from Bloomberg News)