New MetLife Study Looks at Historical Performance of Commercial Mortgages
September 26, 2022
On September 20, MetLife Investment Management (MIM) published a report which examined the longest-known dataset of commercial mortgage loan performance, ranging from 1957 – 2021. The report is an update and expansion of a 2005 report, “Case Study of Leverage and Default Risk over a Full Real Estate Cycle,” published by Moody’s and based largely on MIM’s commercial mortgage-portfolio history.
Like its previous study, the current analysis showed that while the position in the economic cycle when a loan is underwritten is important, the critical factor is LTV. The analysis shows, not surprisingly, that loss rates from higher-leverage loans can increase substantially if underwritten late in an economic cycle. In contrast, loans with more conservative leverage ratios present similar levels of risk no matter when in the cycle they are underwritten.
Besides LTV, the report looks at other underwriting metrics, specifically DSCR and debt yield. The authors note that DSCRs can be deceptive as longer payback periods or lower interest rates can produce higher DSCRs that are not truly indicative of the loan’s risk profile if there is a market downturn and/or a foreclosure. Debt yield, however, can be a more meaningful measure than DSCR in some instances and offers a lender a more standardized view of risk as it indicates potential returns if the lender had to take possession of the property.
The study then examines the relationship between debt yield and cap rates and concludes that the relationship between the two is a more effective tool for mitigating losses. The authors’ analysis shows that loans with smaller differentials between debt yields and cap rates have higher loss rates. As a result, the report concludes that lenders should look at the debt yield relative to cap rates to better gauge losses across a range of economic environments and lender-risk profiles than debt yield alone.