NEW YORK CITY-Over the course of a 17-year period, securitizedcommercial real estate loans in default have generally been smallerbalance. That is changing as larger CMBS loans from 2005 through2007 run aground, Standard & Poor’s says in a new report. Thestudy also predicts that the peak of defaults will be farther inthe future than in previous downturns.

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“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 andco-author of the study, tells GlobeSt.com. “That, coupled with thehigh vacancy rates and the severity of the recent recession, meansit could take even longer” than the 25-month lag between the end ofthe 2001 recession and the peak of annual loan defaults.

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Assuming two years-plus since the technical end to the recessionin June 2009, that could mean defaults continuing to crest wellpast the midpoint of next year, especially as the jobless rate isexpected to remain high into 2012.

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

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“As defaults climbed, so did loss severities,” according to thereport. The loss severity rate jumped to 41.57% in 2009 forresolved loans that had incurred losses, compared to 18.49% in2008. It climbed higher in the first half of 2010 “and isapproaching a record high.”

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At the same time, special servicers are moving loans through thesystem more rapidly. Loans resolved in the first half of ‘10 tookan average of 17.92 months, compared to 21.18 months in ’09 and31.78 months in ’08, according to the study. Slightly more than 46%of the 6,533 defaulted loans between ’93 and ’10 have beenresolved.

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

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Multifamily currently has the second-highest delinquency rate,yet while Nevada, Arizona and Florida have been hit especiallyhard, Thompson points out that the distress in this sector hasgenerally not been due to overbuilding. Aside from a few pocketssuch as Las Vegas, overbuilding has been “constrained across theboard during the current cycle. It’s due more to demandfactors.”

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Those factors would include college graduates moving back inwith 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 theproduct," he says. "If folks weren’t moving back in with theirparents, then they were migrating out of state.”

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

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Paul Bubny

Paul Bubny is managing editor of Real Estate Forum and GlobeSt.com. He has been reporting on business since 1988 and on commercial real estate since 2007. He is based at ALM Real Estate Media Group's offices in New York City.