By the Numbers

CRE CLO collateral performance weakens a bit

Mary Beth Fisher, PhD | October 20, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Higher financing rates and a moribund sales market continue to keep commercial real estate under pressure. Performance in loans backing CRE CLOs has been weakening, with higher delinquency rates mostly due to office and retail properties. Performance relative to CMBS is a mixed bag, though that’s heavily influenced by differences in collateral composition across property types and the ability of CRE CLO managers to modify or replace troubled loans in managed pools. CRE CLO investors looking for cleaner collateral should focus on multifamily deals, where performance is robust. Those willing to venture into more challenging collateral should move towards deals with larger office and retail exposures.

CRE CLO performance broadly is tied to its collateral distribution, which currently is heavily weighted towards multifamily (71%) (Exhibit 1). The next largest property type is office, comprising 13.5%, followed by hotel and lodging (5.3%) and industrial (2.8%). This has shifted a lot over time. In early 2018 multifamily was only 35% of the collateral pool, office was 25% and hotel and lodging was 14%. Pool composition began to shift due to the variable of the pandemic on the property types, as CRE CLO sponsors and investors migrated heavily towards the better performing multifamily space.

Exhibit 1: Collateral composition by property type

Note: Data as of 9/1/2023.
Source: Intex, Santander US Capital Markets

Delinquency rates across all CRE CLO collateral have been rising for the past year (Exhibit 2). There was a surge in delinquencies during the pandemic, but that subsided and performance improved. Delinquencies hit a local trough of about 0.4% in the first half of 2022, then gradually began to increase. The delinquency rate rose above 2.0% in September 2023 for the first time since the depths of the pandemic.

Exhibit 2: Delinquency rates across all CRE CLO collateral

Note: Data through 9/1/2023.
Source: Intex, Santander US Capital Markets

Although multifamily makes up 71% of the collateral, it is contributing very little to the overall delinquency profile of CRE CLOs. The delinquency rate for multifamily in CRE CLOs was 0.8% in September. The deterioration in collateral performance is coming primarily from office and retail. Office delinquency rates had been rising for several months, then increased sharply in September (Exhibit 3) to 7.5%.

Exhibit 3: Delinquency rates of office collateral in CRE CLOs

Note: Data through 9/1/2023.
Source: Intex, Santander US Capital Markets

Retail collateral in CRE CLOs has actually been struggling the most, with delinquency rates in the 8% to 10% range for the past two quarters (Exhibit 4). This has also pushed overall performance down, despite retail representing only 1.4% of the collateral pool.

Exhibit 4: Delinquency rates of retail collateral in CRE CLOs

Note: Data through 9/1/2023.
Source: Intex, Santander US Capital Markets

Lodging took a hit in CRE CLOs during the pandemic, but most loans cured or were bought out from pools. Current delinquency rates for hotels in CRE CLOs are 1.2%.

Comparison to CMBS

It can seem a bit disingenuous to compare CRE CLO performance to that of CMBS. The loans in CRE CLOs are transitional, floating-rate and typically of shorter maturity than 10-year conduit loans, even with extension options. Because CRE CLOs are not REMICs, like conduit and SASB structures, the collateral pools can often be managed to replace or modify troubled loans. And CRE CLO sponsors – who usually retain 20% or more of the equity – are exceptionally motivated to work with borrowers and keep projects and financing terms manageable.

Still, both products are governed to some extent by the overall trends in commercial real estate. The overall delinquency rate for US CMBS rose to 3.8% in September 2023, which was up from 2.5% a year earlier. This was mostly driven by the increase in office delinquencies, which makes a much larger proportion of CMBS than of CRE CLOs.

Delinquency rates by property type in CMBS are also similar to those of CRE CLOs (Exhibit 5). Office delinquency rates in CMBS rose to 5.6% in September, while multifamily was 1.3%. Retail delinquencies in CMBS continue to hover around 6.4%, some of which is a holdover from the pandemic, while some new retail loans in CMBS have also become non-performing.

Exhibit 5: CMBS delinquency rates by property type

Source: S&P Global Ratings

Mary Beth Fisher, PhD
marybeth.fisher@santander.us
1 (646) 776-7872

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.