Commercial Mortgage Defaults Continue to Rise

CU360
August 20, 2009 | COMMENTS

The default rate on commercial mortgages held by U.S. banks may rise to the highest level in 17 years during the fourth quarter 2009, as debt for refinancing remains scarce and the recession drags down rents. The rate is likely to reach 4.1% by year-end, according to property-research firm Real Estate Econometrics.

The projection implies defaults on about $44.3 billion of commercial mortgages, based on the $1.08 trillion of such loans held by U.S. banks in the first quarter, according to calculations by Real Estate Econometrics and Bloomberg. Commercial defaults already are at a 15-year high after climbing to 2.3% in the first quarter, or $3 billion, from 1.6% at the end of 2008, according to analysis of FDIC data.

The projection for this year would match the 4.1% rate seen in 1993 and be the highest since defaults reached 4.6% in 1992 during the savings and loan crisis, when the U.S. created the Resolution Trust Corp. to deal with bad loans. The first-quarter rate was the highest since 1994, when 2.7% of commercial mortgages defaulted.

Default rates likely will increase next year and in 2011 as five-year loans made in 2005 and later start to come due, according to Real Estate Econometrics. The company projects the default rate on commercial mortgages will reach 5.2% by the end of 2010 and peak at 5.3% in 2011 before starting to decline.

Investors in bonds that packaged $62 billion of debt for U.S. offices, hotels, and shopping malls are bracing for more loan defaults through 2010 as analysts say landlords' monthly payments may jump 20% or more.

Principal is coming due on the so-called partial interest-only loans as the recession saps demand for commercial real estate. About $179 billion of such loans were written between 2005 and 2007 and bundled into bonds, according to data from Bank of America Merrill Lynch.

With soaring vacancies and falling rents, some cash-strapped borrowers will fail to cover the higher costs. About 87% of mortgages sold as securities in 2007 allowed owners to put off paying principal for several years or until maturity, compared with 48% in 2004, Morgan Stanley data show.

“The worst is yet to come,” MetLife Inc. Chief Investment Officer Steven Kandarian tells Bloomberg Television. “Typically there's a lag between when the economy softens and when the defaults actually occur.” And while job losses contracted at a slower pace in May and the number of Americans collecting jobless benefits shrank for the first time in almost five months, unemployment will continue to depress non-residential real estate.