The recent CMBS backed by nonperforming commercial real estate (CRE) loans from Rialto Capital Advisors is the beginning of a trend, Fitch Ratings said in a recent report. It is the first CMBS to be backed by nonperforming loans (NPLs) in years.
The $132 million deal's collateral consisted mostly of NPLs and real estate owned or REO properties that were bought by Rialto at a considerable discount to the unpaid principal balance, according to a Fitch presale on the transaction.
The underlying properties comprise commercial and multifamily loans, which represent 90% of Fitchstressed recoveries. The pool also has residential and commercial land and single-family residences, which make up 10% of Fitch-stressed recoveries.
"We expect more securitizations with these types of pools now that there is a benchmark deal to help the market understand what the execution of these transactions will look like," Fitch managing director Daniel Chambers said.
The rating agency also expects a pick-up in CMBS backed by nonperforming product considering the significant distressed commercial real estate volume that is still with servicers and lenders. There is also the rising number of loan sales done to get rid of troubled CRE loans.
The common resolution strategies for troubled CRE loans are modification, foreclosure and liquidation, discounted payoff, and loan sales, although loans sales are increasingly becoming more common.
"Based on recent resolution activity, loan sales are being more frequently used to dispose of troubled loans, particularly smaller balance loans," Chambers said. "We expect to see some of these loans recycled through nonperforming loan securitizations, given the efficiency of securitization relative to alternative financing options available to distressed debt investors."
In terms of the properties, Chambers said the collateral behind these NPL-backed offerings, as exemplified by the Rialto deal, might be a function of the product local to some of the lenders involved in these loan sales.
One obstacle that these deals have to overcome is investor acceptance. According to Chambers, for investors, the primary thing is conviction in the predicted recovery levels on the individual properties.
"These deals often include loans secured by tertiary and unusual property types," Chambers said. "As the visibility of recovery value in these properties has firmed up, market participants can better assess expected recoveries relative to stressed acquisition prices." He added that there was a time sellers and buyers did not agree on the value of these properties, which is now lessactua frequently the case.
Fitch reported that since 1Q09, $161 billion of CMBS loans have been transferred to special servicing. Since 2010, the volume of loans in special servicing has been consistently more than $90 billion. The bank balance sheets also have a considerable number of CRE NPLs. For Federal Deposit Insurance Corp.-insured institutions, roughly $77.7 billion were noncurrent at the end of last year, according to Fitch. In the next five years, with the worst-performing and peak origination vintage loans reaching maturity, Fitch said that the pressure on lenders and servicers to work out loans should grow stronger.
