KBRA, a full-service credit rating agency registered in the U.S., the EU, and the UK designated to provide structured finance ratings in Canada, recently released research on appraisal reduction amounts (ARA), which have climbed in tandem with delinquency rates, according to a release.

After a 60 percent drop in effectuated ARAs in 2022, ARAs climbed in 2023 and 2024 as delinquencies increased 84 percent. ARAs totaling $1 billion (98 loans) were effectuated during full year of 2023, while the year-to-date June 2024 total almost matched this figure, with $842.6 million of new ARAs across 95 loans.

As of June 2024, ARAs totaling $5 billion are in effect across 355 loans (outstanding principal balance of $11.8 billion). This compares to June 2023 when ARAs totaled $4.2 billion for an annual growth rate of 20 percent, the release stated.

With lower conduit CMBS (commercial mortgage-back securities) coupon loans maturing in an environment with higher interest rates, declining property prices, and weak commercial real estate deal volume, delinquencies and ARAs are expected to continue to rise, according to KBRA.

“The combination of increasing delinquencies and the potential assignment of ARAs to existing delinquent loans could significantly amplify ARAs in 2024 and 2025,” the release stated. “Notably, nearly one-third of seriously delinquent loans by loan balance (90-plus, foreclosure, real estate owned, and nonperforming matured balloons) do not have ARAs. Based on the current pace of ARA activity and the trajectory of CMBS 2.0 delinquencies, new ARAs are on track to surpass and potentially double 2023 levels. The rapid rise in ARAs indicates an increase in expected losses that will follow.”

As of June 2024, retail and office properties represent 75 percent of total ARAs, at 42.5 percent and 33.2 percent, respectively.

The average ARA as a percentage of loan principal balance is 42.5 percent, with retail and office above average at 47.2 percent and 46.1 percent, respectively, and industrial at the lowest with 25.5 percent.

ARAs as a percentage of loan balances are similar across loan sizes, including those with balances less than $25 million, $25 million-$50 million, and greater than $50 million (large loans) at 43.4 percent, 43.1 percent, and 41.7 percent, respectively.

For disposed loans, approximately one-half of the loans (43.7 percent by count) had ARAs within +10 percent of their actual realized losses; 72.4 percent were within +20 percent; and less than 4 percent (14 loans) varied by +50 percent.

New York has the largest state ARA exposure of $1.2 billion (23.3 percent of total ARA balance) represented by 79 loans (22.3 percent by count). This is followed by Illinois and Texas with $0.58 billion and $0.50 billion, respectively, with these three states accounting for 45 percent of total ARAs outstanding.