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NEW YORK — To assess the impact of the COVID-19 disruption, Trepp applied an economic and real estate forecasting scenario to a portfolio of 12,500 commercial real estate loans.
The results were perhaps predictable: defaults are expected to increase, in some cases significantly.
In the scenario used by Trepp, the cumulative default rate on all commercial mortgages will rise to 8%, up significantly from the current default rate of 0.4%. The impact will be most immediate and severe in the accommodation industry, with a cumulative default rate approaching 35%. The retail sector will also experience high defaults, with a cumulative default rate estimated at 16% in the scenario. Other large real estate sectors analyzed, such as offices, multi-family and industrial buildings, will experience more measured increases in distress.
The scenario used by Trepp is a modified version of the Severely Adverse scenario of the banking regulators, with changes to capture the largest expected price drops and NOI expected in the accommodation and retail segments. This scenario assumes a sharp drop in GDP, a rise in the unemployment rate (peak at 10%), a fall in interest rates and a fall in asset prices. Commercial real estate prices fall 35% over the first two years of the scenario.
Trepp applied this scenario to a portfolio of 12,500 commercial real estate loans held by commercial banks with a total outstanding amount of $ 77.5 billion. This is a good quality loan portfolio, with a median LTV of 40.9 and a median DSCR of 1.82.
Here’s what Trepp found:
- The mortgage default rate will soar to reach a peak of nearly 10% by the end of 2021.
- Defaults will also increase sharply, peaking at 3.6% at the end of 2021 / beginning of 2022.
- Office default rates will increase, but not so severely. The maximum default rate for office loans in this scenario would be 0.8%
- Industrial and multi-family mortgages will see smaller increases in default rates, peaking at around 0.5%. For both types of properties, the expected declines in prices and NOI mean that LTV and DSCR ratios will hold up better, relative to accommodation and retail.
The impacts of these higher periodic default rates over the 5-year forecast horizon will translate into much higher cumulative default and loss rates for all types of loans, especially housing and mortgage loans. individuals.
- The cumulative default rate for all CRE loans is 8.0%, and with an expected loss severity of 31.7%, the cumulative loss rate will be 2.5%.
- For home loans, the cumulative default rate is expected to be 34.8%, resulting in cumulative losses of 13.1%.
- The cumulative default rate for retail is expected to be 16.0% and the cumulative losses will total 5.3%.
- The other sectors analyzed, in particular offices, collective housing and industrial, will fare comparatively better, with cumulative default rates of around 3% to 4.3% and cumulative losses of the order of 0.8% to 1.2%.
Not as bad as the Great Recession
Trepp notes that while these defaults will be serious, they are not as bad as the defaults and losses suffered during the Great Recession. For example, the highest default rates in the Trepp COVID-19 scenario are 2.7% for commercial mortgages and 0.4% for multi-family mortgages. These rates compare to 4.4% and 4.7% respectively for the Great Recession.
There are several reasons for this, says Trepp.
The scenario takes place over a shorter period of time, which may result in a slightly less severe impact when applied in a model. Perhaps more importantly, the Trepp loan portfolio used for this analysis has good current credit quality, so the loan portfolio starts forecasting with generally healthy LTVs and DSCRs. “In the run-up to the Great Recession, the volume of loans and transactions was very high and underwriting standards had dropped significantly,” he noted.
