Investment products that cobble together risky commercial-real-estate debt are becoming increasingly strained, as more and more of their makeup is taken over by delinquent assets, Bloomberg reported.
The share of distressed debt within these collateralized loan obligations is now four times as high as it was seven months ago, compromising 7.4% of such products. CLO distress rates skyrocketed over 440% in the 12 months ahead of January, according to a report from CRED iQ.
With outstanding CRE loans accounting for an estimated $80 billion of the market, some issuers are already taking on losses.
CLOs function by bundling short-term loans for property renovations and expansions, a form of speculative debt often circumvented by banks and typical mortgage-backed securities.
It’s a market that suddenly surged in the pandemic, as remote work boosted appetite for apartment renovations. Between 2019 and 2021, CLO issuance skyrocketed from $19 billion to $45 billion, Bloomberg found.
But as interest rates have made their way up, and office demand has stayed lackluster, borrowers are having an increasingly tougher time managing their debt.
As with the broader commercial real estate market, this is prompting issuers to extend their maturities, while reworking loans in a manner that’s encouraging to borrowers — such as two or three-year extensions in return for more capital, Bloomberg said.
Others are using cash reserves to buy out delinquent loans, purchasing a record $1.3 billion last year, according to JPMorgan estimates cited by the outlet. In 2022, buyouts stood at just $0.48 billion.
Issues with CLOs reflect a bigger theme in commercial real estate, as even investment grade projects face debt concerns. For instance, office delinquency rates jumped from 5.1% to 6.5% in the fourth quarter.
With problems appearing to worsen for the sector, some have cautioned that a $2.2 trillion wave of distress is set to hit in coming years.
Still, CLO managers are showing some optimism, even as loan origination volumes have remained low, Barclays wrote in mid-March.
“They also see the pullback in lending from banks as a positive for their volumes. Many also expect property transactions to also increase in 2024,” the bank said. “We continue to expect a very limited y/y increase and forecast only $10bn of issuance in 2024.”
