U.S. Commercial Mortgage Defaults Decline as Prices Recover

Defaults on commercial real estate mortgages held by U.S. banks fell in the fourth quarter from the previous three months, the first decline in almost five years, as prices began to recover, Real Capital Analytics Inc. said.

The default rate on loans for office buildings, malls and other commercial properties dropped to 4.28 percent of loan balances from 4.36 percent in the third quarter, according to the New York-based real estate research firm. It was the first such decline since the first quarter of 2006.

The drop “suggests that the sector’s contribution to bank distress may have reached a plateau,” Sam Chandan, Real Capital’s global chief economist, said today in a statement. “As market conditions improve, particularly in larger metros, banks are slowly working to charge off more bad loans.”

The rate of defaults is declining as real estate values start to rise. U.S. commercial property prices gained 5.5 percent in the four months ended December from an eight-year low in August, according to a Moody’s Investors Service index. New York, Washington and other big metropolitan areas are leading the recovery as well-leased properties attract investors.

Commercial lenders face more potential losses. Over the next four years, “a significant portion” of the $1.5 trillion of U.S. commercial mortgages set to mature may not be refinanced because the underlying real estate is worth less than the loan, said Thomas Flexner, global head of real estate at Citigroup Global Markets Inc.

‘Very Significant Headwinds’

“I don’t think that we have for certain hit the bottom,” Flexner said today in an interview with Tom Keene on Bloomberg Television’s “Surveillance Midday.” There are “still a couple of very significant headwinds that we are confronted with that are primarily in the middle-market banking system,” he said.

Defaults on apartment-building mortgages fell to 3.74 percent of outstanding loan balances, from 4.43 percent a year earlier and a record 4.67 percent in the third quarter, according to Real Capital.

For commercial mortgages excluding those on apartments, defaults rose from 3.85 percent a year earlier, the 17th straight quarter they gained on a year-over-year basis, the research company said. Loans in default are past due by 90 days or more or in so-called non-accrual status, meaning the lender doesn’t expect to make a full recovery.

The drop in the balance of loans in default shows lenders modified or sold mortgages, or liquidated the underlying real estate to try to recover part of the debt, Real Capital said.

Shopping Malls, Hotels

About $45.8 billion of loans on office buildings, shopping malls, hotels and other commercial real estate were in default in the fourth quarter, up from $41.8 billion a year earlier and down from $46.8 billion in the third quarter.

Banks held about $1.07 trillion of commercial mortgages and $214.8 billion of apartment mortgages as of the fourth quarter. Many banks, particularly smaller lenders who hold more construction and development loans, “still face serious challenges” managing distressed financing, Chandan said.

Real Capital bases its analysis on bank filings and data from the Federal Deposit Insurance Corp.

Source:  Bloomberg

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