Defaults Still a Long Way from Peaking

NEW YORK CITY-Over the course of a 17-year period, securitized commercial real estate loans in default have generally been smaller balance. That is changing as larger CMBS loans from 2005 through 2007 run aground, Standard & Poor’s says in a new report. The study also predicts that the peak of defaults will be farther in the future than in previous downturns.

“Unemployment is expected to remain elevated in the near term, at levels higher than we’ve seen in the two previous recessions,” S&P’s Larry Kay, director of structured finance ratings and co-author of the study, tells “That, coupled with the high vacancy rates and the severity of the recent recession, means it could take even longer” than the 25-month lag between the end of the 2001 recession and the peak of annual loan defaults.

Assuming two years-plus since the technical end to the recession in June 2009, that could mean defaults continuing to crest well past the midpoint of next year, especially as the jobless rate is expected to remain high into 2012.

With the exception of the healthcare sector, where changes in the Medicaid reimbursement rates caused a high percentage of defaults about a decade ago, most of the defaults in the study have occurred since January ‘09, says Eric Thompson, lead analytical manger for US CMBS surveillance at S&P. In fact, 3,338 of the defaults in the study occurred between January ’09 and June of this year, the cutoff point for the study. That compares to 597 loan defaults in 2008, 249 in 2007 and 6,533 over the study’s 17-year span.

“As defaults climbed, so did loss severities,” according to the report. The loss severity rate jumped to 41.57% in 2009 for resolved loans that had incurred losses, compared to 18.49% in 2008. It climbed higher in the first half of 2010 “and is approaching a record high.”

At the same time, special servicers are moving loans through the system more rapidly. Loans resolved in the first half of ‘10 took an average of 17.92 months, compared to 21.18 months in ’09 and 31.78 months in ’08, according to the study. Slightly more than 46% of the 6,533 defaulted loans between ’93 and ’10 have been resolved.

While the wave of ’05-to-’07 vintage CMBS defaults will start pushing the average balance up—although the number of bad loans will not increase as rapidly—defaults have been highest for borrowings between $5 million and $25 million. “Some of the smaller-balance loans are likely multifamily product, because the smaller, less capitalized borrowers could afford multifamily more than lodging or an office building,” says Kay. “So you have small borrowers that potentially don’t have the wherewithal to carry the loans that they’re just barely covering. Or they don’t have the money to put into deferred maintenance.”

Multifamily currently has the second-highest delinquency rate, yet while Nevada, Arizona and Florida have been hit especially hard, Thompson points out that the distress in this sector has generally not been due to overbuilding. Aside from a few pockets such as Las Vegas, overbuilding has been “constrained across the board during the current cycle. It’s due more to demand factors.”

Those factors would include college graduates moving back in with their parents, or condominiums going on the market as rentals, both of which increased the supply even without overbuilding. Thompson adds that there were job formation issues in some states, “which reduced household creation and reduced demand for the product,” he says. “If folks weren’t moving back in with their parents, then they were migrating out of state.”

Currently leading the pack for both delinquencies and loss severities is hotel CMBS, where 14.8% of the loans are at least 30 days past due and the loss severity rate stands at 39.8%. As with retail, lodging defaults have been more prevalent in the latter part of the study period rather than in the ACLI-driven early days. ““That just reflects the severity of the recession we’ve gone through,” says Kay. “Consumer-related sectors have been affected pretty significantly.”



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