Resolutions Don’t Hold Back Tide of Defaults

NEW YORK CITY-The pace of legacy CMBS loan resolutions may have accelerated in recent months, but not rapidly enough to keep the delinquency rate from climbing, Fitch Ratings and Trepp said last week. Given the traffic in loan sales this year—Miami-based special servicer LNR Partners recently disposed of $1 billion worth of distressed debt in a single portfolio—“that’s a story in itself,” Peter Tobin, managing director of sales and trading at Mission Capital Advisors, tells GlobeSt.com. The fact that the delinquency rate keeps rising “speaks volumes in the face of those liquidations.”

As the delinquency rate continues ticking upward—Fitch puts the September total at 8.66% of Fitch-related loans, while Trepp says it’s 9.05%, the highest on record—the driving factor has changed. “Initially, the wave of bad loans was due to slack underwriting,” says Tobin, whose company has handled numerous sales of non-performing loans. “You had all these pro forma underwritings. In-place expenses and income weren’t used; rather, pro forma was used to basically inflate the value of the property and buy more debt.” When the projected numbers didn’t materialize, the inevitable result was default.

Now, says Tobin, “you see a number of retail and office properties where you may have had a number of smaller, mom-and-pop tenants. Those guys have been hit hardest over the past couple of years. Obviously, the pullback in consumer spending affected those guys the most.”

Many of these smaller owners “were hanging on, anticipating an increase in spending and a decline in unemployment,” Tobin says. “But that hasn’t materialized; the economy has sort of flatlined. So in the past several quarters, a lot of people that may have been hanging on and paying out of pocket have been forced to make a decision. And without a light at the end of the tunnel, the decision has been to hand over the keys.”

Tobin points out that over the next year or two, we’ll see many five-year CMBS deals “coming due at the worst possible time. The class A properties will see some ability to refinance as the capital markets start lending again in those markets, but once you leave the primary markets, the money to refinance is just not there yet. You’re really in a difficult position if you’re the owner of a smaller strip center in a tertiary or rural market.”

As a corollary to Tobin’s observations, Fitch says that 10 states with Fitch-rated CMBS loans have default rates of 10% or more. All but Hawaii also rank among the hardest-hit in terms of unemployment. Leading the way is Nevada, where one in four securitized loans is in default.

“Though certain macroeconomic indicators have been more encouraging of late, CMBS delinquencies will not subside anytime soon,” Fitch managing director Mary MacNeill says in a statement. “National employment underpins demand for every property type and a jobless recovery for the US economy foretells continued challenges ahead for commercial real estate.”

Trepp notes that the news offers something for everyone. “For commercial real estate bears, the fact that the rate once again set a record is a sign that the CRE crisis is not yet over,” according to a commentary in TreppWire. “The CRE bulls, however, can point to the fact that the September increase in the delinquency rate is the second smallest for 2010.”

Although the percentages vary due to differences in the loan pools they’re discussing, both agencies rank lodging as the sector with the highest default rate: 21.31% in Fitch’s view, 19.33% as rated by Trepp. Multifamily comes next in both rankings, followed by retail, office and industrial.

For its part, Moody’s Investors Service said last week that loan defaults have declined significantly since January of this year, with a 94% recovery rate now reducing the overall balance of delinquent CMBS. In this case however, Moody’s was talking about Japan. Domestically, the ratings agency last week affirmed 50 classes of legacy CMBS, downgraded 53 others and put 222 on review for possible downgrade.