Keith Botvinik | Managing Director | Grace Realty Capital LLC
Many multifamily CRE markets are experiencing negative income growth. As you can see from the CAGRs below, expense growth is outpacing revenue. The impact can be seen on CMBS credit quality and performance, with Q3 distress at one of its highest levels, even beyond the GFC. As a follow-up to the state of the market commentary I circulated recently, I wanted to share where I see multifamily loss recognition going forward. A semi-retired EVP and former head of CRE at a regional bank explained why the CMBS world has a high amount of defaults/loans in servicing and why banks don't possess the same statistics.
As shown below, there is a clear economic link between CMBS stress and bank modifications. The difference is in the structure and transparency that triggers impairment reporting and the implementation of remedies. Although covenant breaches are enforceable EOD for CMBS (see Return to Lender below), they are regularly glossed over by banks. The analysis suggests CMBS and bank credit quality are closely aligned—just managed and reported differently. CMBS moves first (hard defaults trigger special servicing); then banks react 2–4 quarters later with loan modifications/extend-and-pretend. What they both embrace is the reverence for nonaccrual, and the reality that bank losses are coming, just lagging behind the more transparent industry data.
When CMBS special servicing rates jump in a property type (like Office) → expect a sharp jump in bank CRE modifications next. When CMBS liquidation timings deteriorate → expect bank collateral values to get stale (appraisals lag reality). When CMBS DSCR trends collapse → bank ACL (allowance for credit losses) needs to rise or risk ratings are underreporting. Banks don't show it in NPLs—they show it in "modifications" under ASU 2022-02. This is the bank-world version of CMBS special servicing. Mods = CMBS special servicing analog, just slower, quieter, and more discretionary.
The links and the charts speak for themselves. What I will add is that CMBS delinquencies exclude cured loans, which suggests greater distress. Loans are considered "cured" and get pulled off the delinquency list when: the interest gets paid; or a deal is worked out to extend and modify a mortgage that wasn't paid off at maturity date; or a forbearance deal is worked out between borrower and lender; or the loan is resolved through a foreclosure sale; or the property is returned to the lender in lieu of foreclosure.
Here’s the side-by-side comparison. The chart shows CMBS credit stress (measured by special servicing rates) next to bank CRE stress (measured by loan modification rates under ASU 2022-02). These numbers are illustrative but economically accurate based on trends from Trepp/Kroll (CMBS) and FDIC/Call Reports + 10-Q disclosures (banks).
As the tide goes out on cash flow in these stained times many folks aren’t going to be able to keep up. The same impairments exist for everybody just treated differently with CMBS distress a leading indicator of hidden bank credit risk. The losses are the same but without regulatory pressure and controls banks can take them incrementally quarter by quarter. Regardless, equity is deteriorating at the same rate for everybody. Both sets share the same characteristics and inevitably will suffer the same fate, value erosion. Once non accruals start accelerating everyone will have to deal with it on equal footing.