Morningstar Credit’s David Putro Sees Around the Corners of the CMBS Market

If you’re receiving Morningstar Credit’s commercial mortgage-backed securities (CMBS)  news flashes, you’re receiving the fruits of David Putro’s labor. Sometimes you’ll get some positive news to accompany your morning coffee, sometimes you’ll be spitting that same coffee over your keyboard — because if there’s one thing the market has taught us over the years, “Them’s the breaks.” 

In good times and bad, the firm’s head of commercial real estate analytics and his team are busy surveilling the vast universe of CMBS loans every day and delivering timely market updates on noteworthy changes to those loans and the properties backing them, such as special servicing transfers, property value — ahem — alterations and leasing activity. 

It’s safe to say there’s never a dull moment in the CRE market today, and CMBS is no exception. On the positive side, the financing source is behind some of the flashiest, $1 billion-plus megadeals hitting headlines today. On the not-so-positive side, there are maturity defaults, loan workouts and lengthy negotiations while properties continue to find their feet — yes, even now — post-COVID. 

Putro joined Morningstar in 2011, and was elevated to head of CRE analytics three years ago. It’s been a whirlwind of a market since then, so he sat down with Commercial Observer from his office in Philadelphia to give us his latest temperature check as well as the good, and not so good, CMBS trends he’s spotting coming down the pike. 

This interview has been edited for length and clarity. 

Commercial Observer: What are some of the big CMBS trends you’re noticing today in your surveillance? 

David Putro: There are a couple of things we’re seeing that the market has also been pretty active in talking about as well. The biggest is the dichotomy between a really active new issue market and a very elevated level of distress that I’d describe as “stubborn” and not going away. 

I read a report based on August servicing data that delinquencies are on the rise today but the total amount of loans currently in special servicing is receding — is that correct? Also, what does this “stubborn” distress look like, exactly? 

We’ve seen some fluctuations over the past couple months because a number of very large loans that were in special servicing have been modified and are leaving special servicing. So, there are a couple of billion-plus-dollar loans that play into those numbers.  

From the general distress aspect, there’s been a set of loans that has really been driving numbers — specifically there’s  somewhere north of $10 billion of loans that have been sitting in special servicing since before 2021. That’s the block of distress that’s not going away. 

Then, on a monthly basis, we’re seeing more and more loans coming into special servicing. A lot of that comes down to a combination of factors, I think, including interest rates. Then, any office loan that’s hitting a maturity today and has any kind of tenant risk is really difficult to refinance. So, we’re seeing an influx of office loans and they all share a common feature in occupancy questions, whether it’s a current depressed occupancy, or the metrics have been good up until now but there’s a major tenant rolling in a year or two that just makes getting that refinancing fairly difficult.

Is there a limit to how long these loans can remain in special servicing? 

The governing documents for the CMBS deals dictate the limits as to what a special servicer can do, but that changes from deal to deal. We’ve certainly seen that on some of the mall loans that extended during COVID, especially where a borrower is coming back for a second or third loan extension and they’re being told by the servicer that there’s no more wiggle room. 

So, yes, there is a limit. But, again, all of these loans have their own stories, from a legal issue to a ground lease complication to subordinate debt in the mix — every time you add another player it further complicates the workout. So, there’s a handful of really large loans and a bunch of other smaller ones in limbo. 

Another part of this, too, is people are still waiting for some market certainty in some cases, which I think is starting to happen. We’ve seen a number of distressed sales happen in San Francisco recently, and there was a good-sized block of distressed office space that was sitting out there previously. Here in Philadelphia, there are a number of large CMBS loans along Market Street that have just been sitting there, and I suspect we may start seeing some movement on those as well. 

It’s one of those things where, once the first transaction happens, others can figure out where the market bottom is, or what the market is, and work off that. But, until you know what the number per square foot is in some of these markets, it’s a waiting game — or maybe a game of chicken. 

What becomes of some of the troubled assets backing CMBS loans in the markets where there isn’t enough market clarity to devise a clear resolution for the asset? 

My team goes out and regularly visits assets in addition to the surveillance work we do in the office. Properties are usually under the control of a receiver by the time they get to a certain level of distress, but in a lot of cases, at least from the outside, it’s actually hard to distinguish a 95 percent occupied from a 60 percent occupied, heavily distressed property. 

From the data side of things, we generally see that once a property hits 60 percent occupancy or somewhere in that range, that’s really hard to come back from, as you’re talking about re-leasing a tremendous amount of space. A lot of companies are still trying to figure out what back to work looks like — even now, with few companies taking down 250,000 square feet in one swoop. 

Obviously, it can happen in New York, to some degree. It can happen like in San Francisco with tech companies or whatnot. But, if you’re a building in Philadelphia or in Chicago, you’re going to re-lease space in steps, and you’re not looking for one big tenant but 10 tenants that each take 25,000 square feet, and it just makes it all that much more challenging. We’re not seeing a whole lot of pickup once these buildings get to a certain low point occupancy-wise.

There was a small sigh of relief when the Federal Reserve made the quarter-point rate cut recently. But, from your perspective, how helpful is it in the grand scheme of things?

The quarter point probably benefited new deals, but, for the distressed assets we look at, a quarter point is not going to move the needle in terms of whether they can refinance or not. They’re so far underwater that that little bit of a break on interest rates won’t help much. 

I do think, for a lot of what’s been sitting in special servicing for some time, the lack of clarity around values is an issue, and there’s also been a limited set of buyers. 

What’s the next CMBS shoe to drop?

There’s this giant group of regional malls that got multiple extensions during COVID, and they may not show as distressed right now, but they’re performing at levels that will make refinancing almost impossible whenever they get to their modified, negotiated maturity date. The problem with a full workout for these assets is it takes a lot to run a mall or dispose of a mall, and that’s part of the reason why a lot of these mall loans are extended. 

For a servicer or CMBS trust to take back a bunch of malls that all got hit by COVID and never quite recovered, and all of a sudden you have a special servicer trying to work out or dispose of five malls, it just logistically makes a very difficult workout process. But that’s why I think, even if the existing stock of distress finds some way to work itself out in the next five, six months, there’s this shadow group of malls that are going to become distressed and keep that number elevated for a bit.

On the flip side, A-plus malls are doing very well, but that’s a different trend. 

What else are you seeing, trend-wise? 

In CMBS, it’s not uncommon for a borrower to cash out on a refinance, but I think there’s a lot less cash-out refinances happening today, which is good as you’d generally rather see a cash-in or a neutral refinance than a cash-out refinance. 

Even on the distress side, there were a couple of really big single-asset, single-borrower loans last year that got modified but with $100 million of new equity coming in. I occasionally groan at “extend and pretend” being overused — if somebody’s putting $125 million of equity in to extend a loan, I don’t think there’s a lot of “pretend” there. We’ve also seen smaller loans, say a $50 million or an $80 million loan, being extended with $5 million of new equity going in, which, at those loan balances, is not an insignificant number. Now, most of these loans have not been modified long enough to see what the ultimate outcome is and whether that pays off, yeah, but it does seem like there’s an effort there and it’s a bit different from the rubber-stamping we’ve seen in the past. 

So, more consideration being given around loan extensions is a noticeable enough trend that we’ve started trying to do some additional research on it. If you go back even two years, you’d occasionally see a borrower come out of pocket to facilitate a loan extension, but it was not all that common. Now, while I’m not going to say it’s the norm, it’s definitely not the exception. 

What was your path to CMBS? 

I grew up here in Philadelphia, and I’ve lived here my entire life. I actually got into commercial real estate by accident. I took a job at GMAC Commercial Mortgage, which is no longer around, but I took a job there in the IT group of all things. I was working closely with the securitization team, and at some point they thought I could just jump over to CMBS. So I literally went from being an IT guy on a Friday to working on the CMBS team the following Monday. 

This was 2005, so I was there for the frothy part of the CMBS market [in the lead-up to the Global Financial Crisis] and, unfortunately, I was also there for the downside. I quickly went from being part of “Let’s sell these loans into a trust” to “Let’s try to sell these loans to anybody that’ll take them.” It was a quick turnaround. 

What were some of the biggest lessons you learned from your time there? 

I learned something new every day then, and I also learn something new every day today. Every deal is different, every property is different, every loan is different. So you come across things you just haven’t seen. Just this morning, my analyst had me look at a very odd ground lease on a property he was writing up. And even just wrapping your brain around how the surroundings are structured is just interesting. 

The other thing I’ve learned is every time there’s a problem on the horizon, there’s an awful lot of smart people in this industry to find a way to make things work. So whether that was — dating myself here — Y2K when I was an IT guy, or risk retention, or Dodd Frank, or the maturity waves, people in our industry find ways to adapt and make things work. It’s easy to think about CMBS as this static financing mechanism, but things change over the course of time, and it just always makes things so interesting. 

Cathy Cunningham can be reached at ccunningham@commercialobserver.com.