Fitch: U.S. CMBS Defaults Set to Escalate

Loan defaults will continue to escalate for U.S. CMBS, with an additional 4.4% likely in 2010 and the overall rate to exceed 11% among Fitch-rated deals by the end of the year, according to Fitch Ratings.

New CMBS loan defaults increased more than fivefold last year (1,464 conduit loans totaling $17.75 billion), with 34% taking place in the fourth quarter alone.

"Fourth-quarter default rates reached their highest ever levels both in principal balance and number of loans with no clear signs of stabilization," said managing director Mary MacNeill in a press release.

In fact, 2009 defaults on their own surpassed the cumulative number from the inception of the CMBS market through 2008 ($17.74 billion).

Another area of concern is large loan defaults, which increased dramatically last year.

In 2009, 56 loans over $50 million in size defaulted compared to just five in 2008, and most of the defaulted loans came from 2006-2008 vintages, according to Fitch.

Delving deeper into specific vintages, 2007 deals led in defaults last year, accounting for 35.6% by principal balance.

"The aggressive underwriting and higher leverage in the 2007 vintage is leading to substantially higher default rates," said MacNeill.

Fitch predicts 10-year cumulative default rates on 2007 Fitch-rated CMBS to reach 27%.

For the first time in five years, multifamily was not the property type with the most new defaults, with that distinction going to retail (32.3%) last year.

Following retail was multifamily (22.1%), office (20.2%) and hotel (17.8%).

Fitch projects sizeable default increases for each property type, with rates likely to increase at accelerated rates for office and hotel loans.

"Office defaults spiked in the fourth quarter last year, with further rental and net operating income declines likely through next year before a rebound takes place," said senior director Richard Carlson in the same press release.

"Larger concentrations of hotel loans in recent vintages will translate to higher defaults, particularly among luxury properties, resort destinations and those hotels heavily reliant on group and convention business," said Carlson.

Fitch also said the credit outlook for the U.S. equity REIT sector remains negative for 2010 in spite of various positive market developments.

However, Fitch may revise the outlook for the sector to stable if property-level fundamentals, liquidity and access to capital continue to strengthen in 2010.

Access to the capital markets has remained strong for U.S. equity REITs so far this year.

Fitch said to date U.S. REITs have raised $2.1 billion through the equity markets and $9.1 billion from the unsecured bond and unsecured convertible bond markets in order to extend debt maturities and/or repay borrowings.

As a result, liquidity coverage ratios have improved.

Fitch noted in its April 6 Global Economic Outlook that the economic recovery appears to be gathering momentum.

The United States economy, in particular, expanded 1.4% in fourth quarter, with all components of domestic demand and exports picking up.

Fitch expects the economy to register 3% growth this year.

However, hiring rates are still weak, and Fitch Ratings believes it will likely take some time before unemployment falls noticeably from its peak of approximately 10% last year and in early 2010.

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