More Distressed Debt Likely On the Way

In early February, Trepp LLC reported that CMBS delinquency rates had hit an all-time high by the end of January and that the percentage of fixed rate CMBS loans paying off on their balloon date was dropping. According to Trepp, the US rate for CMBS loans delinquent for 30 days or more hit a record high of 9.34% in January, and the total value of delinquent loans now exceeds $61.4 billion.

Many had thought that US CMBS delinquencies had turned the corner in October 2010, when the delinquency rate declined, but since that time, the rate has risen by 76 basis points. This is despite the fact that 2010 saw nearly $12 billion of new issuances that should not see much, if anything, in the way of delinquencies for a while. And although delinquencies on a total percentage basis may drop due to the spate of new issuances expected in 2011, older vintage CMBS can be expected to show increased delinquencies for some time. Hospitality and retail properties have rallied a bit, but office and multifamily assets have been slow to recover and industrial property delinquencies have recently taken a turn for the worse, led by a default under a $317.5-million loan secured by 6.2 million square feet of warehouse space located in 14 states.

The drop in the percentage of loans paying off on their balloon date is also disturbing. While 51.5% of maturing loans paid off on time in December 2010, the payoff rate declined to 38.7% in January 2011. From a historical perspective, the December 2010 figure seems to be the outlier. Over the past 12 months, according to Trepp, the average percentage of loans by balance paying off each month has been approximately 34.5%. The January '11 number would be more in line with the one-year trailing average indicating that borrowers continue to have difficulty refinancing at maturity.

About $65 billion in CMBS loans will mature in 2011, but the overall commercial mortgage market will see approximately $275 billion maturing this year and, over the next three years, nearly $1 trillion will be due. New issuance of CMBS is projected by most market participants to be in the $35-billion-to-$50-billion range for 2011, which means that borrowers will likely be highly dependent upon the life companies, commercial banks and GSEs to refinance the expected demand. According to the FDIC, bank failures are projected to continue at a rate of about 40 per quarter in the short term, and no one knows how the Obama administration's GSE proposals will affect multifamily lending. Although the administration has vowed to support the GSE effort, the political debate that is expected in Congress could have a chilling effect on GSE lending.

There has been plenty of competition for core and core-plus property loans, but little interest by any commercial lenders in loans below $10 million or those secured by properties in secondary and tertiary markets. Unless community banks can rally or CMBS originators decide to focus upon larger deals in terms of the numbers of loans pooled, smaller borrowers may have trouble refinancing maturing loans. The ontinuing stress on CMBS and bank portfolios and the difficulty that borrowers will face in refinancing their mortgages means that the amount of distressed commercial mortgage debt available to investors should continue to increase. As they say, "there's a silver lining in every cloud."

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