Commercial Realty Loans Buck 'Subprime' Trend

While recent headlines on the residential mortgage side are all about rising defaults, delinquencies and foreclosures (particularly on subprime loans), the story on the commercial mortgage end is altogether different.

On the residential side, lender strategies that fueled homeownership growth among marginal borrowers with the use of all sorts of creative lending, in a historic low interest rate environment, have now come home to roost. In contrast, delinquencies on commercial mortgages have hit a new low.

Low commercial mortgage delinquencies have come about in a climate of good economic fundamentals that has enabled low vacancies and rising rents on various commercial real estate property types in the last few years.

Of course, the commercial mortgage sector could have its own version, albeit on a diminished scale, of the current residential-side problems a few years down the line, considering that commercial mortgage lenders too have gotten very aggressive in the last few years.

The question now is whether the subprime problems are going to spill over into the larger economy and cause a broader slowdown that could in turn impact the performance of commercial mortgages. This doesn't seem likely at the moment considering that the economy is doing fine taking into account other factors such as growth in the business sector, with technology at the helm, that is also fueling strong job creation.

These considerations have kept the Federal Reserve in a holding pattern on interest rates, with the central bank's concerns about inflation making it hold off on an interest rate cut that might otherwise help the economy tide through the housing slowdown. And on the other hand, while an interest rate hike could help deal with concerns about inflation, it could negatively impact the housing sector.

Against this background, two rating agencies report a decline in the delinquency rate on properties backing commercial mortgage-backed securities. Standard & Poor's Ratings Services reports that the delinquency rate on S&P-rated CMBS loans fell to 0.39% at the end of 2006, an eight-year low, with the amount delinquent seeing its best decline on a year-over-year basis. The previous low of 0.36% was seen in January 1999, according to the New York-based credit rating agency. Also five of the six major commercial property types saw a low in delinquencies that has not been seen in a number of years (with the industrial property sector being the sole holdout). According to the credit rating agency, the amount delinquent on loans it has rated fell 34% last year, with declines more than double the declines seen in 2004 and 2005, two years that had previously seen the best performances yet.

At the end of 2006, $1.88 billion on S&P-rated CMBS was delinquent, compared to $2 billion in 2001.

One factor that S&P says contributed to the decline is a reduction in the hurricane-related delinquencies that resulted from the 2005 hurricane season. Another factor is the record CMBS issuance seen in 2006. Delinquencies on healthcare properties backing S&P-rated CMBS were down 65%, followed by lodging delinquencies with a 44% decline, office (32%), multifamily (30%) and retail (25%). Industrial properties, however, saw a 5% rise in delinquencies.

Fitch Ratings also reports that the big rise in CMBS issuance last December helped push delinquencies on Fitch-rated CMBS down 0.05% to 0.37%. According to Fitch, the delinquency rates on all property types, except hotel, remained stable.

Hotel delinquencies were up $84 million, mostly due to one particular transaction. The addition of 21 new deals totaling $43.2 billion to the Fitch universe helped with the decline. Considering only loans with a seasoning of a year or more, delinquency was at 0.50%, Fitch reports.

(c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com