KBRA Credit Profile (KCP) K-LOC Index: June 2023

KBRA:

The KBRA Loan of Concern (K-LOC) Index was 19.35% in June 2023, up from 19.12% in May 2023. The K-LOC Index increased month-over-month as we identified 77 new loans ($2.15 billion) as K-LOCs in our conduit CMBS coverage universe in June, including 35 loans ($1.65 billion) collateralized by office. Conversely, we removed the K-LOC designation on 85 loans ($1.75 billion).

K-LOC Indexes for the 20 largest metropolitan statistical areas (MSA) based on conduit unpaid principal balance (UPB) are provided in this report (see MSA K-LOC Indexes and Delinquency Rates). Nine MSAs had a K-LOC Index above the benchmark as of June 2023, including Chicago (37.05%), Denver (31.47%), and San Francisco (28.23%).

About the Index

The K-LOC designation serves as KBRA’s primary metric used to identify loans that are in default or at heightened risk of default based on KBRA Credit Profile’s (KCP) proprietary research and analysis. KCP is a division of KBRA Analytics. The K‑LOC Index for June 20­23 is a composite of 2,596 K-LOCs with an aggregate UPB of $62.78 billion across 443 conduit transactions.

For any given cohort, the index is the quotient of its aggregate K-LOC balance and the cohort’s defeasance-adjusted UPB. As it includes loans at risk of default, it is a useful, forward-looking credit barometer. The K‑LOC designation is determined by our team of analysts, who perform in-depth monthly analysis on individual transactions and the underlying loan collateral. For the purposes of this report, we exclude legacy CMBS (2008 and earlier).

In Figure 1, we highlight the changes to the K-LOC Index and the underlying property type allocations since December 2019. The proportion of office K-LOCs has increased as businesses implement hybrid work models and reevaluate space needs. The long-term nature of office leases has slowed the adverse impacts of demand dissipation and we anticipate higher levels of volatility will continue to influence credit quality. Looking ahead, as CMBS loan maturities accelerate, inflationary pressures and higher interest rates are expected to have an impact on the pace and magnitude of K-LOC identifications.

We also track servicer watchlist, special servicing, and delinquency rates across our conduit coverage universe to further quantify credit trends. The delinquency rate increased significantly in 2020, peaking at 9.58% in June 2020, and was 4.32% in June 2023 compared to 1.23% in February 2020, prior to COVID’s impact on global economies (see K-LOC Index Versus Delinquency and Servicer Watchlist Status section).

The following figures track the K-LOC Index over time, examine the index by property type and MSA, and compare the index to delinquency and servicer watchlist status across different cohorts.

• The $170.2 million 211 Main Street loan was identified as a K-LOC in June due to uncertainty surrounding future collateral occupancy ahead of loan maturity in April 2024. The loan is participated across the JPMCC 2017-JP6 ($65.2 million), DBJPM 2017-C6 ($60 million; CMBX 11), and JPMCC 2017-JP7 ($45 million) transactions. The collateral, a 417,266-sf office building in downtown San Francisco, is fully leased to Charles Schwab & Co, which was acquired by TD Ameritrade in late 2020. Shortly after the acquisition, Schwab relocated its headquarters to Westlake, Texas, from San Francisco. While the lease with Schwab does not expire until April 2028, expectations are that the company will reduce its footprint in San Francisco in the near term. The single-tenant lease to Schwab introduces binary default risk within the context of the loan’s upcoming maturity and recent volatility in the banking and financial services sector.
• We identified the $88.8 million Equitable Plaza loan (COMM 2014-UBS3) as a K-LOC in June due to near-term lease rollover risk coinciding with loan maturity in June 2024. The loan is collateralized by a 688,292-sf office building in Los Angeles. As of December 2022, collateral occupancy was 68%, in line with 2021 but down from 82% in 2020. Despite reduced occupancy, cash flows in 2022 were sufficient to fund debt service. Through 2023 and 2024, 67% of current leases by square foot are scheduled to rollover, which could hinder the borrower’s ability to secure refinancing dollars if lease expirations materialize into vacancies.
• The $389.2 million Prudential Plaza loan was identified as a K-LOC in June based on expectations the loan would be transferred to the special servicer, which occurred in July 2023. The loan is collateralized by two adjoining office towers in Chicago spanning a combined 2.3 million sf. The borrower has indicated interest in extending maturity to provide additional time to invest capital into the asset as part of its plan to hold the property long term. Loan maturity is scheduled for August 2025. The borrower acquired the subject in April 2018 for $680 million ($300/sf) and assumed the existing CMBS debt. The collateral was 78% occupied as of March 2023, down from 83% in December 2022. Since issuance, the property has generated cash flow sufficient to fund debt service with a DSCR of 1.66 reported in 2022. The loan is participated across COMM 2015-CR26 ($107.9 million; CMBX 9), CD 2016-CD2 ($70.3 million; CMBX 10), CD 2017-CD3 ($65.7 million), JPMDB 2017-C5 ($61 million), CD 2016-CD1 ($46.9 million; CMBX 10), and COMM 2016-COR1 ($37.5 million; CMBX 10).
• We identified the Legg Mason Tower loan ($127.5 million; MSBAM 2012-C5; CMBX 6) as a K-LOC in June with consideration to elevated near-term lease rollover risk and evidence the largest tenant, Legg Mason (44%), will be vacating the collateral, a 612,613-sf office building in Baltimore. Franklin Templeton, which acquired Legg Mason in 2020, signed a 60,000-sf lease at an adjacent building in 2022 and has indicated plans to relocate from the subject. Legg Mason’s lease expires in August 2024. As of March 2023, the subject was 99% leased and the year-end 2022 financial statement reflected a DSCR of 1.89.

Figure 4: K-LOC Index Versus Individual CMBX K-LOC Indexes

• CMBX Series K-LOC Indexes have generally trended with the benchmark index over the trailing 24 months ended June 2023. Recent increases in the CMBX 6 and CMBX 7 indexes reflect a higher K-LOC concentration as new loans are identified as K-LOCs and performing loans reach maturity and are paid off.

Figure 5: Property Type K-LOC Balance by Vintage (June 2023)

• By balance, 35.98% of K-LOCs are collateralized by office, followed by retail (31.85%), lodging (15.55%), and multifamily (3.81%).

Figure 6: Primary K-LOC Reason Stratification (June 2023)

• Each loan identified as a K-LOC is tagged with a primary K-LOC reason, which signifies the main driver of credit concern. The primary reason is often supported by other factors contributing to the overall heightened risk of default. As distressed loans progress through delinquency and resolution pipelines, our primary K-LOC reason is updated to reflect those changes, including transfers to the special servicer, forbearance, and loan modifications.

Spotlight: Ashford Hospitality Trust Provides Guidance on Hotel Portfolios

More than 80% of lodging loans by principal balance were identified as K-LOCs in early 2021 mainly due to pandemic-related stress. The sector has seen a significant rebound in performance since then, particularly among properties in destination markets, though business travel bookings have been much slower to recover. Some studies suggest corporate travel spending will approach two-thirds of pre-pandemic levels in 2023 with a full recovery to 2019 levels forecast in late 2024 or 2025. That said, roughly one-quarter of U.S. companies do not anticipate their travel spend to return to pre pandemic levels, citing higher travel prices as a key concern. The tepid recovery in corporate lodging demand coincides with challenging macroeconomic conditions, including a higher interest rate environment and rising hotel operating costs. Additionally, some owners of flagged hotels that deferred capital expenditures and renovations during the pandemic owing to reduced cash flows are now confronted with renewed efforts from major hotel brands to force compliance with property improvement plans (PIP). The obstacles are greater for owners that reallocated reserve funds to cover operating shortfalls. In some cases, it is not economically viable for borrowers to outlay additional capital toward property improvements, and they may instead opt to forfeit their interest in the collateral entirely.

In early July, Ashford Hospitality Trust, Inc. (Ashford), which owned 100 hotels across 26 states as of December 2022, provided guidance on how it plans to handle several of its hotel portfolios collateralizing loans in two CMBS securitizations. The AHT1 2018-KEYS securitization is collateralized by six floating rate, interest-only (IO) loans secured by 34 hotels (7,270 keys) across 16 states. Each of the six loans had an initial two-year term and five one-year extension options for a fully extended maturity in June 2025. The loans were structured with minimum debt yield requirements—ranging from 9.75% to 11.14%—for the borrower to exercise a fourth extension option to June 2024. Ashford also noted each of the six loans fell short of its debt yield threshold but that it would remit a combined $129 million in principal to bring the Pool C, Pool D, and Pool E loans in compliance with the debt yield requirement and secure an extension. Conversely, Ashford announced it would not contribute the estimated $255 million in principal required to extend the Pool A, Pool B, and Pool F loans, and spoke to the possibility of conveying the 19 hotels collateralizing these loans to the AHT1 2018-KEYS trust. Further, Ashford indicated that recent attempts to sell the underlying properties yielded bids below the respective loan balances.

In addition to the $255 million in principal curtailment, Ashford estimates it is saving roughly $80 million in capital expenditures by relinquishing the 19 hotels from its portfolio. In Figure 9, we stratify the collateral for the extended (pools C, D, E) and non-extended (pools A, B, F) loans by operating brand. We observed a higher concentration of brands catering to business travel within the non-extended cohort of loans.

Sources: KBRA Credit Profile (KCP), Trepp

In its July press release, Ashford also addressed MSC 2017-ASHF, which is collateralized by the $415 million Ashford Hospitality Trust Portfolio loan secured by 17 hotels (3,128 keys) in seven states. The loan matures in November 2023 and can be extended for one additional year. Ashford does not anticipate that extension will necessitate a principal curtailment.

Additionally, the $249.4 million Ashford Prime Portfolio loan (BHR 2018-PRME) received a $120.6 million curtailment in June 2023 in connection with its maturity that month. The loan, which is collateralized by four hotels (1,685 keys) was extended to June 2024 in tandem with the curtailment. Ashford also remitted a combined $85.8 million to extend the loans collateralizing the JPMCC 2018-ASH8 and AHT1 2018-ASHF securitizations in February and April 2023, respectively. Both now mature in 2024 and have one one-year extension option remaining. KCP subscribers can view all CMBS loans with exposure to Ashford Hospitality Trust, Inc. here.

MSA K-LOC Indexes and Delinquency Rates

We examine K-LOC balance by MSA to quantify credit behavior across various markets. An MSA is defined by a geographic boundary associated with a large, urbanized core or population nucleus, including adjacent regions with a high degree of social and economic integration. For CMBS properties in a given MSA, we divide the balance of all K-LOCs by total principal balance, based on allocated loan amount (ALA), to calculate the index.

Our data comprise K-LOC Indexes for the 20 largest MSAs, which represent nearly two-thirds of all conduit debt in the KCP coverage universe. We also feature property type allocations (see Figure 10) and stratify delinquency rates (see Figure 11) by MSA to provide additional insight into the performance of individual markets.

Additionally, we follow the 20 MSA Indexes across the trailing 24 months ended June 2023 (see Figure 12). For each MSA, the index is tracked against the MSA-specific CMBS conduit delinquency rate as well as specially serviced and master servicer watchlist rates.

K-LOC Index Versus Delinquency and Servicer Watchlist Status

The K-LOC Index is generally higher than delinquency and specially serviced rates, and serves as a more meaningful gauge of default risk relative to the servicer watchlist (SWL), which may include false positives with regard to true credit concerns.

The delinquency rate for conduit transactions was 4.32% in June 2023, up from 4.24% in May 2023 and the highest rate recorded since April 2022. The delinquency rate compares to the K-LOC Index of 19.35% and the specially serviced rate of 6.28%, which is up from 6.14% in May.

The June 2023 delinquency rate is up from 4.2% in June 2022 but down from 6.86% in June 2021. The 30-day delinquency rate increased year-over-year (YoY) to 0.33% in June 2023 from 0.29% in June 2022 while the 60-day delinquency rate was relatively stable, moving to 0.08% from 0.07% over the same period. Meanwhile, the 90-day delinquency rate, which also includes loans that are more than 90 days delinquent, dropped YoY to 0.68% from 1.11%. The share of loans with a foreclosure status also decreased YoY to 1.2% in June 2023 from 1.5% in June 2022. Loans in foreclosure may be more or less than 90 days delinquent. The matured nonperforming status increased YoY to 0.93% from 0.37%, while the real estate owned (REO) status shifted to 1.1% from 0.86%.

Want more? In-depth research and analysis at the transaction level, including collateral valuations and loss projections, are available within our KCP reports, which are published monthly for every deal in our coverage universe and are available at kcp.kbra.com.

The KCP platform is a subscription-based surveillance service that covers more than 1,200 CRE securitizations with an aggregate balance of more than $800 billion. For each deal, monthly reports are posted to our website that contain color and commentary for CMBS transactions and their underlying loan collateral. Unlike other sources of valuation and loss data, which primarily rely on models, the service is supported by a dedicated team of analysts, who can more readily appreciate the non-homogeneous nature of CRE, loan, and transaction structures, as well as imperfect servicer information.

Recent KCP Publications

• KCP Insights: Office Overtakes Retail in Rising K-LOC Index
• KCP Credit Alerts: Portals I Sale Flops plus San Diego Hotel Trades and Three Office Loan K-LOCs
• KBRA Credit Profile (KCP) Loss Lookback: June 2023
• KCP Credit Alerts: Ashford Hospitality Trust Provides Guidance on Hotel Portfolios
• KCP Credit Alerts: Updated Delaware Hotel Appraisal Matches KCP Value plus Office and Retail K-LOC Additions
• KBRA Credit Profile (KCP) K-LOC Index: May 2023

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