Investors Scoop Up Office-Tower Bonds Even as Delinquencies Rise

(Bloomberg) -- Office buildings are increasingly going delinquent on their mortgages, and yet bond buyers can’t seem to get enough of the properties. 

A pair of commercial mortgage bonds backed by offices were sold this week, with pricing levels shrinking over the course of the deals as investor demand amped up. 

Money managers are buying these securities in an uncertain time for office buildings. The overall CMBS delinquency rate rose for the first time in 18 months in December as several new office delinquencies pushed the rate up 0.20 percentage point to 4.33%, according to a Jan. 10 report from DBRS Morningstar. 

The percentage of delinquent office loans rose 23.1% to $4.05 billion from a year earlier, driven by several large office loans, DBRS analysts Steve Jellinek and Erin Stafford wrote. The four troubled office loans pushing the CMBS delinquency rate up included 245 Park Avenue in New York and 181 West Madison Street in Chicago, with a combined balance of more than $1.2 billion, according to DBRS. 

Investors may have good reason to be sanguine about at least the highest-quality office properties. Remote working may affect the sector less than investors feared, because many employers may look for enough space to accommodate peak office attendance and encourage workers to come in, according to DBRS. 

Barclays and Goldman Sachs on Wednesday arranged and priced a $305 million CMBS backed by a high quality, so-called Class A three-building office campus in Bellevue, Washington called The Summit. Affiliates of KKR & Co., Inc. were the borrowers for the loan underlying the bond, whose senior-most tranches received Triple-A ratings from Moody’s and DBRS Morningstar. Risk premiums narrowed five basis points from guidance levels on the AAA piece.

Meanwhile, Deutsche Bank arranged and priced a $467 million CMBS backed by loan cashflows on Hudson Commons, a 26-story Class A office building in Manhattan’s midtown west neighborhood. The borrower was Fifth Street Properties, LLC, a joint venture between CommonWealth Pacific, LLC and CalPERS, and the most senior tranche received Triple-A grades from DBRS Morningstar and Moody’s.

Investors have clamored for securitized bonds that offer a little more yield than other asset-backed debt and corporate paper. There have been a series of other single-asset single-borrower (SASB) commercial mortgage bonds sold in recent months tied to urban office buildings.

HNA’s Bankruptcy

For 245 Park Avenue in New York and 181 West Madison in Chicago, the delinquency was caused by PWM Property Management, an arm of Chinese conglomerate HNA Group, filing for bankruptcy. Both properties feature strong occupancy and low leverage, mitigating factors that DBRS believes will enable the loans to avoid any losses. 

September 2020 occupancy at 245 Park Avenue, a 1.7 million-square-foot office building near Grand Central Terminal in New York, was 90%, in line with the issuer’s underwritten occupancy of 91.2%. Because the loan was conservatively underwritten, the 2020 net cash flow would need to decline by more than 60% before it was too low to cover debt, that is, before the debt service coverage ratio fell below 1.  

Meanwhile, a $258.1 million loan on 175 West Jackson and $100 million loan on 135 South LaSalle also backed by offices in Chicago, fell 30 days delinquent as well, the ratings firm said.

Office properties that are less desirable, so-called Class B and Class C buildings, and likely “not ESG certified, that had big tenants leaving, particularly in cities with new development over the last couple of years, could start seeing some of these hiccups,” analysts from Trepp, a commercial real estate data company, said in a weekly podcast earlier this month. 

“We saw a couple of those last month which led to a spike in the office delinquency rate,” Trepp’s Manus Clancy, Joe McBride and Martha Coacher said. 

However, the uptick in office delinquencies this year may be “episodic” rather than “catastrophic,” they noted.

Despite the fact that the pandemic exacerbated existing problems with retail and malls, and impacted rents and tenancy in big-city office buildings, sales of CMBS without backing from government-sponsored enterprises hit a post-crisis record last year of more than $155 billion, according to data compiled by Bloomberg News.

Money managers were eager to buy the securities because they pay higher yields than high-grade corporate bonds or asset-backed securities, and many are floating-rate, which is attractive if interest rates rise.

There is a robust pipeline of new deals in the queue for the first quarter. 

Relative Value: Agency MBS

• Goldman Sachs Asset Management remains underweight agency MBS, as strategists expect demand-supply dynamics to remain challenged in 2022 as the Fed accelerates the taper of its purchases and as supply remains elevated due to a strong U.S. housing market, according to its weekly fixed income note
• Strategists are also mindful of interest rate volatility and the potential for quantitative tightening in the second half of the year, they said

Quotable

“(CLOs) are traditionally seen as only for specialists but you’re clearly seeing much broader interest,” Goldman Sachs chief credit strategist Lotfi Karoui said in an interview.  “If you’re looking for value that’s where you need to go”

What’s Next

ABS transactions in the queue for next week include CarMax (prime auto), NewTek (business loan), Foursight (near prime auto), American Credit Acceptance (subprime auto), New Residential (single family rental), SeaCube (container lease), Freedom Financial (consumer loan ABS), and Westgate Resorts (timeshare) 

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