Stay of Execution: COVID-19 Has Hotel CMBS Backed into a Corner

The lodging sector has quickly felt the sharp drop in performance caused by the COVID-19 outbreak. 

Even before the outbreak, real estate firms were projecting a slowdown in hotel revenues. Earlier this year, CBRE (CBRE) had predicted a 0.1 percent decline in hotel revenue per available room (RevPAR) for the year. 

Two weeks ago, CBRE revised its forecast, reporting that the disease would cause a projected 37 percent decline in hotel RevPAR in 2020 — a more than 60 percent drop in the second quarter alone, before somewhat stabilizing in the third quarter.

For the week of March 22 through 28, occupancy and average daily room rates (ADR) declined 68 percent and 39 percent year-over-year, respectively, and contributed to a RevPAR decline of 80 percent for the week, according to data from research firm STR that was noted by S&P Global in a data release on April 2.

One of the biggest questions right now is what will become of mortgage loans backed by hotels and packaged into commercial mortgage-backed securities (CMBS) conduit pools and single-asset, single-borrower (SASB) transactions, which are rated and released into the market for public investment by investors such as life insurers and pension funds who use the market to fetch stable returns for their accounts. 

The liquidity crunch that has spawned from a cessation of travel and business activity across the country has put enormous pressure on hotel owners and operators who have borrowed from the CMBS market and are now staring down the next few months in anticipation that their hospitality holdings will serve as nothing but big, empty boxes, rather than revenue generators. 

Most everyone is lying in wait for federal aid packages to go into effect while trying to triage existing and ever-evolving troubles. Brokers are getting flooded with calls from borrowers searching for advice on how to approach their servicers to alert them of the fundamental problems with their collateral and to receive some relief, according to a broker source who spoke to CO anonymously to avoid any business conflicts. 

”Right now, the CMBS market is more or less frozen, so there are billions of loans that are sitting on balance sheets — CMBS issuer balance sheets — that cannot be securitized. Investors are unclear about the complexity and uncertainty that we all feel regarding COVID-19,” said Lisa Pendergast, the executive director of the Commercial Real Estate Finance Council (CREFC), a major industry trade group that’s been lobbying the government over the last few weeks to provide necessary support for commercial mortgage markets.

Pendergast added: “To the extent we continue to discuss the market with government officials, we want to make sure they’re doing a good job in protecting the U.S. balance sheet. We continue to highlight the credit performance of the CMBS market. I did the numbers on SASBs, and there’s never been a loss to AAA and there’s only been one small loss to BBB+ to the tune of just $3,000.”

According to analysis from Fitch Ratings that was released yesterday, more than 2,600 commercial real estate borrowers — representing over $49 billion in mortgage loans — have sought potential debt relief in the first two weeks of the U.S. COVID-19 outbreak, ending on March 29. This includes borrowers in 42 SASB CMBS transactions secured by hotel and retail properties. Fitch compiled the data — which quantifies relief requests from CMBS and Freddie Mac (FMCC) borrowers — from Wells Fargo (WFC), Midland Loan Services, Keybank (KEY) and Berkadia Commercial Mortgage, the four largest CMBS master servicers. Hotels represented nearly 47 percent of relief requests, according to Fitch. Fitch also highlighted that the relief requests aren’t yet directly linked to defaults, being that the virus’ heavy impact on revenues, and the subsequent delinquencies it would cause, hasn’t yet been fully realized in these secured loans. Fitch found that 87 CMBS loans, totaling $2.8 billion, have already been sent to special servicers and that more of these transfers “are expected in May and June as servicers respond to missed loan payments and additional relief requests.”

Those relief requests have been focused on loan payment forbearance, the reallocation of monetary reserves in order to fulfill debt service requirements or to remedy shortages in funds for operating expenses and also waivers of default for business closures, according to Fitch. Borrowers who are reaching out for “hardship inquiries” are saying that government restrictions have led to them receiving non-payment notices from tenants and closed businesses.

Midland Loan Services — a division of PNC Bank — is sending out mass text message updates to market participants, saying that it’s in “triage mode” and has no prescribed responses to what’s happening due to the uniqueness of the situation, as per the messages that were provided to CO anonymously. Midland is advising borrowers who have received March rents to pay their April debt obligations and has said that it has created a task force to solely handle COVID-19 related inquiries, urging people who have heard from their borrower clients to reach out to its asset management department for assistance. Midland, via PNC Bank media relations, declined to comment for this story.

Moody’s Investors Service vice president and head of CRE and CMBS research, Kevin Fagan said he’s talked to servicers and “they’re all well aware and immediately got calls from many hoteliers, and one of the issues was [debt service] covenants; so, if a borrower were to fall below a certain level, [they would] have to put in a cash flow sweep, but there’s no cash flow. Larger sponsors in SASB deals have reached out to servicers to say they have no revenue but that they still plan to pay our debt service. Servicers are keenly aware of what’s going on, and no one is looking to trip people up on any technical things.”

He said the servicer’s role is to assess whether they should advance funds to borrowers to meet obligations, and “at this stage, servicers are equipped to advance as necessary. [Borrower] reserves [might] keep a hotel afloat for two or three months, but for those with deeper pockets, it could be significantly longer. The smaller hotels and independents are less likely to have substantial reserves.”

While the full impact on the hotel CMBS sector hasn’t yet fully manifested, due to the fact that the U.S. is still in the early stages of an economic fallout of the outbreak, all the parties in a CMBS transaction — from the borrower, to the lender, or lenders, to the master and special servicers — are looking at possible carnage over the next few weeks and months if recent injections of monetary aid from the Federal Government prove insufficient in supporting borrower’s obligations. 

Provisions in the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act that was passed on March 27 are aimed at helping provide liquidity via credit lines to small businesses, which many hotel operators, even including larger ones, can get waivers to be eligible for; that liquidity spigot was officially opened on April 2. The government has indicated that CARES can be extended, the provisions ramped up to $6 trillion, as needed, as everything progresses.

The Paycheck Protection Program (PPP) was established with the CARES Act, which hoteliers will look to first to cover their debt obligations, according to Moody’s Fagan.

“[They will go to that first] so to not fire employees and for utility and mortgage expenses. PPP will be the first thing that keeps them alive in the very short term, but it’s only $350 billion in this first iteration of the CARES Act…and it’s on a first-come first-serve basis,” he said, adding that PPP loans are sized to cover 2.5 times monthly payroll.

Also, industry trade groups have been pushing for CMBS to be included in the new 2008 Term Asset-Backed Securities Loan Facility (TALF) program that was reestablished by the Federal Reserve on March 23 to further provide liquidity to securities markets. The market was initially excluded from aid packages in 2008, before being added just a few months later; industry participants and observers hope the same will happen this year.

CREFC’s Pendergast said that her organization is trying to “unlock those frozen markets and turn to the federal government for the TALF program…I’m hoping it’s a matter of time before the CMBS market becomes eligible collateral for TALF.”

Pendergast added: “In 2009, commercial real estate development and operations of existing real estate contributed $1.1 trillion to GDP; that’s 18 percent of GDP, and the [current] overall debt outstanding is massive — $4.5 trillion in debt. The CMBS market is responsible for about 30 percent of that, so to have 30 percent of the liquidity that’s provided out of this market seems problematic, at the very least.”

The market represents a substantial amount of liquidity that should always be available to borrowers, who will inevitably want to turn to the sector to support themselves once the dust settles on the pandemic, Pendergast said.

“If you think about it, when we come out of the other end on COVID-19, a lot of borrowers, including hotel owners, are going to need that financing to get back on their feet and refinance their mortgages,” Pendergast continued. “While we’re all stopped as a country, if you have a loan that’s maturing, you’ll probably get some kind of extension, but at some point you’re going to need to refinance that loan. And that’s when you want those pockets of liquidity to be open fully; green lights everywhere. To the extent that we don’t have a CMBS market that’s functioning properly, that’s a big chuck of the total liquidity that’s available to borrowers.” 

Overall CMBS delinquencies ticked up slightly in March, cutting off a three-year-long downward trend in the figure, but there’s a “deluge” coming, according to Trepp commentary released yesterday. 

Travel cratered and hotels were put under enormous stress during the 2008 financial crisis, but it was a much slower burn than what the sector is experiencing today. In the first eight months after Lehman Brothers’ bankruptcy in September 2008, RevPAR dropped by more than 20 percent, according to analysis from Moody’s Investors Service. Revenues bottomed out, and it wasn’t until 2012 that ADR rates rebounded and occupancy broke 60 percent.

In just the last few weeks, hotel RevPAR has fallen off the table completely. There are mass closures throughout the country, across all hotel segments, and it remains to be seen what will ultimately happen to hotels in conduits and SASB transactions. Similar to previous crises that have rocked the lodging sector, analysts predict that resort-style and luxury hotels as well as the hotels that mostly service business travelers and events and conferences will have their revenues hit the hardest, with select- and limited-service venues — assets that have experienced less of a negative impact on revenues in past disruptions — faring slightly better.

In terms of how the overall CMBS sector has responded, according to data reporting and commentary from Newmark (NMRK) Knight Frank released on March 30, new issuance demand is “still non-existent,” but the global advisory firm noted that “secondary bonds have shown signs of life over the past few business days. After hitting highs in the 300s, AAA spreads for CMBS conduits have settled significantly on the heels of positive news surrounding the CARES Act nearing approval. We have seen CMBS secondaries tighten to the mid-200s range as of late [the week of March 23]. On [March 30], we saw a few bonds attract bids in the high 100s.”

For hotels, specifically, the sector’s troubles with the coronavirus had immediate impacts. The week of March 23, the American Lodging and Hotel Association (AHLA), a leading industry trade group, released a report that anticipated that nearly half of all hotel employees across the country have already lost or will lose their job in the next several weeks as the outlook for the sector remains grim. Last week, a record 6.6 million U.S. workers filed for unemployment, which was double the previous record set the week prior. And recently, the Federal Reserve Bank of St. Louis estimated that more than 47 million people in the U.S. could lose their jobs due to the disease. 

While it would take time for hotel loan defaults to materialize, heightened delinquency risk in the sector will not abate as long as the pandemic continues to stifle travel due to social distancing measures and voluntary and mandatory quarantines. On April 1, President Donald Trump said that he was considering restricting flights and travel to coronavirus “hot spots” across the country. The sector would also struggle to rebound even after the virus’ hold loosens should it ultimately push the economy into a sustained recession.

On April 2, CoStar (CSGP) Group released an analysis saying that $11 billion of hotel CMBS loans — backed by more than 1,500 U.S. hotel properties — that are coming due in the next six months are at risk. CoStar highlighted Los Angeles, San Diego and Orlando, Fla. as markets that are in line to be hit particularly hard.

In terms of a recovery, a “V-shaped” rebound that’s been pushed by economists and analysts alike suggests that as soon as the effects of the disease subsides, consumers will want to get out and travel after being stuck in their homes for an extended period of time. But from a credit perspective, Fagan says that’s off the mark. 

“Looking at it from a credit perspective, we’re not just going to magically be done [with this] one day,” he said, adding that there are likely to be lingering economic impacts, which will keep travel from rebounding immediately. “There could be a phasing in of lenient social distancing measures, [effecting] things like group travel,” which is planned far in advance.

“A sharp V-Shaped recovery is an inaccurate way to look at it,” Fagan added.