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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Commercial Real Estate Assessment By the COP

The inevitable commercial real estate crisis still looms, this time the COP chimes in:

The Congressional Oversight Panel today released its February oversight report, “Commercial Real Estate Losses and the Risk to Financial Stability.” The Panel is deeply concerned that a wave of commercial real estate loan losses over the next four years could jeopardize the stability of many banks, particularly community banks, and prolong an already painful recession.

Commercial real estate (CRE) loans made over the last decade – including retail properties, office space, industrial facilities, hotels and apartments – totaling $1.4 trillion will require refinancing in 2011 through 2014. Nearly half are at present “underwater,” meaning the borrower owes more on the loan than the underlying property is worth. While these problems have no single cause, the loans most likely to fail are those made at the height of the real estate bubble. The Panel notes, however, “Even borrowers who own profitable properties may be unable to refinance their loans as they face tightened underwriting standards, increased demands for additional investment by borrowers, and restricted credit.”

Community banks, unlike the largest Wall Street banks, face the greatest risk of insolvency due to mounting commercial real estate loan losses. According to federal guidelines, 2,988 banks nationwide are classified as having a “CRE Concentration.” None of these banks are among the 19 largest bank holding companies. Forecasts project that banks will suffer their worst losses well after the timeframe examined by the stress tests – an exercise conducted only on the nation’s 19 largest bank holding companies – and well after Treasury’s authority expires under the Troubled Asset Relief Program (TARP).

The Panel found that “a significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American.” When commercial properties fail, it creates a downward spiral of economic contraction: job losses; deteriorating store fronts, office buildings and apartments; and the failure of the banks serving those communities. Because community banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery and extend an already painful recession.

The full report is available at

Since we all have been talking about this inevitable and impending CRE bust, it seems kind of strange that the COP would issue such a report without specific intentions in mind. One can assume that this report along with others will be utilized in order to justify additional programs to provide corporate welfare to failing CRE projects in the form of additional bailout programs.

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Moody’s Commercial Property Index Shows 7.6% Decline in May

The MIT Center for Real Estate reports a 7.6% Decline in Commercial Property Prices:

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Commercial Real Estate – Bernanke Concerned

After everyone else has been talking about it for years, now Bernanke Says Commercial Property May Pose Risk for Economy:

Federal Reserve Chairman Ben S. Bernanke said a potential wave of defaults in commercial real estate may present a “difficult” challenge for the economy, without committing to additional steps to aid the market.

Bernanke, testifying before the Senate Banking Committee today, urged lenders to modify “problem” mortgages to avert defaults. Christopher Dodd, the Connecticut Democrat who chairs the panel, told Bernanke that “some have suggested” the commercial market “may even dwarf the residential mortgage problems” in the U.S.

The state of commercial real estate was one of the most- asked-about subjects in questioning by lawmakers so far in Bernanke’s two days of testimony on the economy. Bernanke said today in the Senate and yesterday at the House Financial Services Committee that it’s too early to tell how effective the Fed’s main initiative in the area will be.

The Term Asset-Backed Securities Loan Facility, a Fed emergency program that lends to investors to purchase securities backed by consumer and business loans, began accepting commercial mortgage-backed securities as collateral last month.

Fed policy makers will extend the TALF, currently scheduled to expire Dec. 31, should they judge financial markets are still “some distance from normal operation,” Bernanke said today.

TALF Extension

“We will certainly be monitoring the situation, and if markets continue to need support, we will be extending the final date of that program,” Bernanke said.

It “may be appropriate” for the government and Congress to consider “fiscal” steps to support the industry, Bernanke said today. Ideas for fresh support for the market could include government guarantees for commercial mortgages, Bernanke also said today, while noting no proposal on the subject has emerged.

U.S. commercial property prices fell 7.6 percent in May from a month earlier, bringing the total decline to 35 percent since the market’s peak, Moody’s Investors Service said in a report this week. Commercial properties in the U.S. valued at more than $108 billion are now in default, foreclosure or bankruptcy, almost double than at the start of the year, Real Capital Analytics Inc. said earlier this month.

Yesterday, more than a half-dozen members of the House panel mentioned or asked Bernanke about the topic, with Chairman Barney Frank saying there’s a “great deal of fear” that a wave of commercial defaults will produce economic problems similar to those caused by residential mortgages.

“As the recession’s gotten worse in the last six months or so, we’re seeing increased vacancy, declining rents, falling prices — and so, more pressure on commercial real estate,” Bernanke said yesterday. “We are somewhat concerned about that sector and are paying very close attention to it. We’re taking the steps that we can through the banking system and through the securitization markets to try to address it.”

One of the main issues for the industry is that the market for debt backed by commercial mortgages “has completely shut down,” the Fed chief said yesterday.

Considering that Bernanke said in 2007 that there was no housing bubble and that the subprime problems was contained, and said in 2008 that housing will stabilize by the end of 2008, the statements above can only mean one thing: “A disaster in commercial property is impending.”

Commercial property crunchtime is here. And the public is waking up to it.

As I said in December 08:

I expect that in 2009 commercial real estate will finally be recognized by the wide public as the disaster it is. Amercia doesn’t need any more Malls. Companies with high exposure to commercial retail properties will suffer.

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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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