Commercial Mortgage Backed Security Delinquencies Hit Record High

On Mish’s blog I cam across the latest Realpoint Delinquency Report:

In January 2010, the delinquent unpaid balance for CMBS increased by another $4.3 billion, up to $45.94 billion from $41.64 billion a month prior. The overall delinquent unpaid balance is up 326% from one-year ago (when only $10.79 billion of delinquent unpaid balance was reported for January 2009), and is now over 20 times the low point of $2.21 billion in March 2007. The distressed 90+-day, Foreclosure and REO categories grew in aggregate for the 25th straight month – up by $7.42 billion (28%) from the previous month and over $27.95 billion (508%) in the past year (up from only $5.51 billion in January 2009). This included a substantial jump in 90+-day delinquency in January 2010.


Other concerns / dynamics within the CMBS deals we are monitoring which may affect the overall
delinquency rate due to current credit market conditions in 2010 include:

  • Balloon default risk is growing rapidly from highly seasoned CMBS transactions as loans are unable to payoff as scheduled. In many cases, collateral properties that have otherwise generated adequate / stable cash flow results are not able to refinance their balloon payment at maturity, due mostly to a lack of refinance proceeds availability. This scenario has added to loans with distressed collateral performance in today’s credit climate.
  • Some five-year and seven-year balloon maturity risk is also on the horizon for more recent vintage pools from 2003 through 2005 where little no amortization has taken place due to interest-only payment requirements. Within this area of concern, large floating rate loan refinance and balloon default risk continues to grow, as many of such large loans are secured by un-stabilized or transitional properties that are soon to reach their final maturity extensions (if they have not done so already), or fail to meet debt service or cash flow covenants necessary to exercise in-place extension options.
  • Aggressive pro-forma underwriting was the norm on loans originated for 2005 through 2008 vintage transactions, many with debt service / interest reserves required at-issuance. The balance of such reserves is declining more rapidly than originally anticipated, and many are close to default or transfer to special servicing (if not already there). Exacerbating such concern is the large unpaid balance related to loans underwritten with DSCRs between 1.10 and 1.25 as any decline in performance in today’s market could cause an inability to meet debt service requirements. This is especially evident with the partial-term interest-only loans that will begin to amortize in the near future, or those that have recently converted.
  • Declined commercial real estate values and diminished equity in collateral properties may prompt more struggling borrowers with marginal collateral performance to walk away from properties.
  • A cautious outlook for the hotel sector remains as many sizeable hotel loans from 2005-2008 vintage pools have reported poor or declined results in 2009 (especially on the luxury side) or were transferred to special servicing for imminent default and / or debt relief. Many properties have had to significantly lower rates to maintain an acceptable level of occupancy across the country and in some cases have experienced severely distressed net cash flow performance as a result. Our expectations are that even more of these loans may be asking for debt relief in the near future and may ultimately default if a resolution is not reached.
  • Continued weakening in retail performance may lead to increased loan defaults as we have not yet experienced the full affect of retailer consolidation, closings and possible bankruptcy (i.e. many loans secured by collateral with troubled retailers as an active anchor).
  • Layoffs, bankruptcies and downsizing have impacted office vacancies across most MSAs, including historically strong markets like New York City, and this trend is expected to continue.
  • External factors mitigating risk include indications that credit liquidity is showing signs of improvement via foreign investors, and public REIT’s are showing the ability to restructure balance sheet debt. Political and governmental focus on job creation in 2010 along with increased support of mid-tier community banks to ease the credit crunch and stimulate lending may affect the overall commercial real estate markets as a whole.
  • On the other hand, as three new issue deals closed in late 2009 and more new issuance is expected to come to market in 2010, some of the delinquency growth we have experienced in the trailing 12-months may yet be offset somewhat by any new issuance’s speed to market in 2010.
  • In addition, liquidations of severely distressed defaulted loans picked up speed in the latter half of
    2009, while modifications and forbearance at the loan level continue to be discussed between
    borrowers and special servicers that may also result in a delinquency “leveling-off” period.


Special servicing needs have had a huge increase over the past year. We are about one year into Commercial Property Crunchtime and it seems to be gaining steam.

The impact of CMBS TALF which runs out by the end of this month has of course been negligible. All in all, about $9.8 billion have been settled since its inception, according to the NY Fed’s TALF announcements.

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CMBS Talf Launches – Nobody Cares

A few days ago the Fed said most eligible CMBS OK for TALF:

Most commercial mortgage-backed securities eligible under published guidelines for the Term Asset-Backed Securities Loan Facility will also meet other Federal Reserve criteria, the Fed told investors on Friday, according one investor and a dealer.

Uncertainty over which CMBS could still be rejected from the TALF program next week has created confusion and capped gains in the $700 billion market, which the Fed wants to help unlock with the lending program.

The assurance by the Fed “will help, but we expect the market will be cautious,” Citigroup analysts said in a research note obtained by Reuters.

CMBS derivative index prices rose after the Fed conference call, according to one investor.

Today the program launched, and Investors request $669 mln in TALF loans for legacy CMBS:

Investors requested $668.9 million in loans for legacy commercial mortgage-backed securities on Thursday in a slow start for a key government program aimed at reviving the commercial real estate market.

The Fed is offering loans to investors for commercial mortgage-backed securities under its Term Asset-Backed Securities Loan Facility, or TALF, in an attempt to revive markets both for new and existing commercial bonds.

Lowering lending costs in commercial real estate could help ease refinancings by borrowers, who are increasingly defaulting on loans for a lack of credit.

Thursday was the first time the Fed accepted existing bonds under the TALF and the second round for its newly issued CMBS TALF program.

Investors did not request loans for newly issued CMBS in June or July.

It seems like CMBS TALF is off to a slow start. $668 million out of $700 billion is a drop in the bucket. Don’t expect it to pick up significantly. Commercial property lenders are loaded with non performing loans, precisely because lessees are going out of business or are unable to make their full payments. Demand for new loans is dried up. As I explained before, what the initiators of this program are missing…

(…)is the fact that the consumption credit expansion has brought about an abundance of retail space in malls, shopping centers and elsewhere. On top of that, a lot of businesses from the lending business were utilizing a significant portion of prime office space.

Now those businesses that were utilizing these spaces are going out of business. The recession is trying to send a signal that the resources are needed elsewhere. They are unable to make their rent payments. The owners of the properties start defaulting on the loans made during the credit expansion. The lenders notice that way too much space was built. There is no demand for any more retail space. In fact, there is a significant surplus. Nobody wants any more retail space. People are sick and tired of debt and over consumption.

Now, what are those very lenders going to do when they receive additional loans from the Fed, at around 2.9% to 3.7%, maybe even more for higher maturities. So they would have to earn at least an additional 100 basis points, probably more, in rental yield in order to make this investment worth their while, and that over the next 3-5 years.

Is this going to happen in an environment of falling prices for commercial properties, falling rents, and record vacancies? No, absolutely not. When people have had enough of something, they’ve had enough. If this is still not clear, I would recommend reading Robert Prechter’s example on Jaguar Inflation which I posted in Inflation and Deflation Revisited.

CMBS TALF will be a miserable failure, just as all other lending facilities launched by the Fed. It is possible that this failure will actually expose the dire situation of commercial lenders and accalerate the downward spiral. Thus, look out for the aftermath of first CMBS TALF auction on July 16th. Rather than it being a cure, it is likely that it will usher in a significant acceleration of commercial property loan defaults.

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Commercial Mortgage Backed Securities Downgraded by S&P

Commercial property crunchtime continues to unravel as Downgrades Hit Commercial Mtge-Backed Securities Market:

Bonds backed by commercial mortgages were hit Tuesday after Standard & Poor’s downgraded several CMBS issues amid continued signs of strains in the market for loans to build office malls and shopping centers.

The CMBX Series 5, the most recent derivatives index based on bonds backed by commercial mortgages, fell three points to 72 cents on the dollar on the downgrades, according to Derrick Wulf, a senior portfolio manager at Dwight Asset Management in Burlington, Vt.

S&P cut several of these securities because of a recent change in its rating methodology.

“They have put a lot of bonds on watch for downgrade after updating their methodology, and this is making the market nervous,” Wulf said.

The commercial real estate market is grappling with a worsening outlook. Delinquencies have risen to about 3%, with hotels seeing the greatest month-to- month increase at 3.26%, up from 2.02%, according to a note from Moody’s Investors Service. The aggregate delinquency rate is likely to go up further, to between 5% and 6% by the end of the year, according to Moody’s estimates.

Banks holding commercial mortgages on their balance sheets are expected to feel the pinch as borrowers default on their loans. On Tuesday, Goldman Sachs ( GS) reported stellar second-quarter results but took a $700 million hit on its holdings of commercial real estate mortgage loans. At the end of the quarter, Goldman had $6.4 billion of commercial real estate loans that were “marked really in the low 50s,” meaning reduced by almost half their original valuation, said David Viniar, Goldman’s CFO, Tuesday on the bank’s conference call.

More downgrades are expected, which means more volatility ahead for the CMBS market, as S&P is expected to “roll out the results of their new methodology over the next three to six months,” said Darrell Wheeler, head of securitization research at Citigroup, in a note to clients.

The downgrades mean these bonds are no longer eligible for cheap financing under the Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF.

“We think that regardless of S&P’s lack of justification for their methodology changes, if they intend to downgrade bonds, then they should get on with it as it will provide investors with some clarity on which bonds they can buy and finance with TALF,” Wheeler noted.

At this point, the market is “getting bifurcated,” Wulf said, adding that TALF-eligible bonds are doing better than the ones that can no longer be bought using the Fed’s cheap loans.

The central bank will offer another installment of these loans on Thursday.

On Tuesday, the GG-10 A4, a benchmark commercial mortgage backed security, was trading about 100 basis points wider than its close of 675 basis points on Monday after it was downgraded multiple notches from the pristine triple-A to just a notch above junk status at triple-B minus, Wulf said.

Two other rating agencies, Moody’s and Fitch Ratings, haven’t cut their ratings on the bond so far.

It is indeed curious that these downgrades coincide with the beginning of CMBS TALF. As I pointed out 5 days ago:

CMBS TALF will be a miserable failure, just as all other lending facilities launched by the Fed. It is possible that this failure will actually expose the dire situation of commercial lenders and accalerate the downward spiral. Thus, look out for the aftermath of first CMBS TALF auction on July 16th. Rather than it being a cure, it is likely that it will usher in a significant acceleration of commercial property loan defaults.

These downgrades may be just one corollary of what I am expecting.

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