There has been a lot of talk about measures trending upwards in the capital markets, such as inflation, yields or the chance of a recession. Now cash balances, as a percentage of pool balances on commercial real estate (CRE) collateralized loan obligations (CLOs), have caught the attention of industry observers.
Cash balances on CRE CLOs have generally trended upward for nearly half of 2022, hitting a high of 4.8% in September, according to analysts at Kroll Bond Rating Agency. The trend appears to be rooted in an increase in loan payments, while reinvestments trend downward, according to recent research from the rating agency’s CMBS oversight team, titled “CRE CLO Cash Balances Trend Upward as Market Slows.”
In general, cash balances varied widely across transactions.
That reverse trend could indicate that issuers are facing challenges new loans for reinvestment in the asset class, according to analysts Margit Gregus, a senior director; Roy Chun, a managing director and Catherine Liu, an associate, all on KBRA’s CMBS oversight team. The balances equal $1.5 billion across 33 managed deals issued since 2021, which were the focus of KBRA’s investigation, according to the report.
On the surface, cash balances look positive for transactions, but cash earns little to no return compared to loans. The higher amounts therefore represent a drag on transactional cash flow, the rating agency observed.
“As a result, there is less income available for distribution to floating rate liability structures,” analysts wrote. “It usually affects the securities in reverse sequential order, starting with the preferred certificates – which are usually held by issuers.”
Where it all began
Cash escalations registered a slight increase in January 2022, the rating agency observed. After that, cash balances remained relatively low, at 2.5% of each pool’s respective balance until April 2022. Then cash balances climbed steadily for the next five months before the October contracting. Transactions typically build cash balances as set aside during the typically six-month accrual periods when the transactions close.
As for October, CRE CLO reinvestment activity increased, reducing cash to $1.3 billion, or 3.9% as a percentage of pool balances, according to KBRA.