CMBS Performance Continues to Strengthen

As the economy continues to grow and expand, delinquencies on commercial mortgage-backed securities are also touching new lows. This follows as a strong economy creates increasing demand for all sorts of commercial space, bringing vacancies down and also leading to the possibility of higher rents. And the higher levels of job creation and higher interest rates that a strengthening economy engenders also bode well for multifamily properties by encouraging household formation and rendering homeownership more expensive.

Delinquency rates on a base of Standard & Poor's-rated U.S. commercial mortgage-backed securities fell to a seven-year low of 0.58% in the first quarter, the lowest level since 1999, Standard & Poor's reports. The delinquency rate also dropped from 0.84% at the end of 2005, according to the rating agency. "Since its peak of 1.96% in December 2003, the delinquency rate has declined 70%, partly due to record volume issuance," noted Eric Thompson, a credit analyst/director in Standard & Poor's CMBS surveillance group. What he sees as "more telling" is that the actual amount delinquent fell by a substantial 38%. At the end of the first quarter, delinquencies totaled $2.48 billion on a base of $445.7 billion of CMBS, the rating agency reports.

Larry Kay, a credit analyst/director in Standard & Poor's Structured Finance Ratings group believes that "although it may be too early to call this reversal the start of a longer term trend, current economic conditions may be starting to shape individual property segment performance."

Overall, S&P has seen multifamily delinquencies fall 17%, since peaking last September. And over the same period, the rating agency has seen retail delinquencies grow 22%. Going forward, it is likely that as a slowing housing market, and rising interest rates, impact the ability of consumers to dip into their home equity, and slow down consumer spending, the performance of retail property could be further negatively impacted.

As for the impact of last year's hurricanes - Katrina, Wilma and Rita - S&P reports that they were responsible for only about 7% of the delinquencies in S&P's CMBS universe in the first quarter. At the end of the first quarter, $4.02 billion of S&P-rated CMBS was identified to be in the hurricane-impacted zone. Only about 4% of this collateral is delinquent, down from a peak of 11% last November.

Multifamily properties were the ones that accounted for the majority of the hurricane-related delinquent amount.

S&P believes this is because multifamily borrowers "which tend to be smaller and less capitalized, have delayed making debt service payments while they wait for insurance settlements to recover lost rental income or to repair or rebuild a property."

And Fitch Ratings reports that CMBS delinquencies are at 0.69% as of April, a mere 0.01% uptick from the March level of 0.68%. Multifamily properties represent 32% of the delinquencies but make up only 20% of Fitch's CMBS base. Multifamily properties also contributed 34% of the newly delinquent loans for April, with retail and office properties next at 17% and 16%, respectively. Fitch is seeing vacancy rates for multifamily properties decline and expects the sector to improve further as homes become less affordable and interest rates continue to go up.

Multifamily properties have also benefited recently as rental properties have been moved towards condo conversions. Fitch senior director Patty Bach doesn't expect the beneficial effect of condo conversion to continue for long though, especially in markets like Las Vegas and South Florida, "where significant condo supply has recently come on line or is in the construction pipeline." Considering only transactions with over a year's seasoning, Fitch reports a 0.04% drop in CMBS delinquencies to 0.89%.

Fitch also reports that CMBS has weathered Hurricane Katrina "reasonably well" so far from a ratings standpoint. In the long term, however, the rating agency expects the impact of Hurricane Katrina on CMBS to be determined by whether or not the displaced Louisiana businesses and individuals return to the affected region. "Temporary assistance, such as disaster relief being provided by FEMA and other relief organizations and business interruption insurance claims, is helping property owners make debt payments, which may be keeping delinquencies artificially low," according to Ms. Bach.

"Some borrowers are paying out of pocket to keep loans current until insurance proceeds are finalized, which may lead to higher CMBS delinquencies if proceeds are not enough to repair or rebuild properties."

Properties located in New Orleans' French Quarter (which has a 45% exposure to Katrina) and downtown New Orleans (which has a 12% Katrina exposure) are likely to perform better than others in the city in the short term, Fitch expects. In the long term though, the city's recovery is key to their performance.

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