Defaults Reach 16-Year High

NEW YORK CITY-With $4.5-billion rise in volume during the fourth quarter, the default rate on commercial mortgages reached 3.82% at the end of 2009, the highest since the 4.1% default rate last seen in 1993, said Real Capital Analytics in a report released late Tuesday. Given that the Federal Deposit Insurance Corp. has said that banks’ losses are largely driven by commercial real estate loans, it stands to reason that the agency said on Tuesday that its list of “problem” lenders similarly reached a 16-year high of 702 institutions.

However, neither commercial mortgage defaults nor the number of institutions on the FDIC’s so-called “Problem List” have peaked. According to published reports, FDIC chairman Sheila Bair said she expects more bank failures this year than there were in ’09, which itself saw the highest number since 1992. Bair says increased losses on commercial real estate exposure will be largely to blame.

And Sam Chandan, global chief economist and EVP at RCA, tells GlobeSt.com, “We project that default rates for commercial mortgages will rise to 5.1% by year-end 2010 and will peak at 5.4% by year-end 2011.” He adds that these projections assume “limited additional policy intervention in support of bank lenders with concentrations in commercial real estate.”

RCA’s projections for commercial mortgages are separate from those for multifamily loans, and the company’s definition of “commercial real estate loans” is narrower than the FDIC’s, which also includes land and development borrowings. Currently, the default rate for apartment properties is higher than it is for the commercial sector at 4.44%. The year-over-year increase in the default rate was greater: up 250% from 1.77%, compared to a 234% rise from the Q4 2008 rate of 1.63% for commercial loans.

Yet RCA predicts that the peak for multifamily defaults–5.3%–will occur by the end of this year, considerably earlier than that for commercial properties. By the end of 2013, 4.4% of commercial mortgages and 4.1% of multifamily mortgages will be in default, according to RCA.

Institutions with assets of $10 billion or more have the highest default rates on commercial and multifamily mortgages at 4.62% and 4.88%, respectively. But lenders of less than $100 million in assets have higher delinquency rates in these sectors, according to RCA data, and smaller lenders in general have higher concentration of commercial and multifamily real estate.

“For institutions with $100 million to $10 billion in assets, concentrations are approximately 33%,” according to RCA. “For institutions with $10 billion or more in assets, concentrations are 12.5%.” That being said, the top tier of banks holds 48.3% of the outstanding commercial and multifamily loans.

Current trends, according to Chandan, suggest that “deteriorating multifamily and commercial mortgage performance has the potential to impact the broader economy, principally by constraining lending by regional and community banks in other areas, such as small business lending.” He points out that although commercial real estate exposure is greatest at regional and community lenders, “there are meaningful differences in commercial mortgage performance across institutions of similar size, geographic exposure, and concentration level. This suggests that each bank’s institutional capacity in managing commercial mortgage distress is an important contributor to realized losses.”