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Experts Say Commercial Delinquencies Are Likely to Keep Rising

Although an anticipated upspike in commercial mortgage delinquency rates has not materialized so far, industry watchers believe that a spike is on the horizon. Commercial mortgage delinquencies are tied to the state of the economy though, and the Fed's easing of interest rates by 50 basis points at its November meeting could very well get the economy back on track and bode well for mortgage delinquencies going forward. However, the impact of a possible war in Iraq could upset the benefits realized from the Fed's pre-emptive action.

Mark Zandi, chief economist with Economy.com, said at the Urban Land Institute's fall meeting in Las Vegas, that while rumor has it that any war will be relatively quick, with no impact on energy prices, "it is also easy to make a scenario where the invasion does not go well." Mr. Zandi pointed out that every single post-World War II recession in the U.S. - with one sole exception - has been preceded by spiking energy prices. And if the war with Iraq doesn't go well and energy prices spike over a period of time, Mr. Zandi sees a significant risk of recession.

Standard & Poor's reports that commercial mortgage delinquency rates fell in the third quarter to 1.9%, following a flat delinquency rate in the second quarter. Sectorwise, delinquencies in the health care, retail and office sectors declined, while lodging and multifamily sector delinquencies rose. Standard & Poor's analysts Roy Chun and Larry Kay believe that health care delinquencies peaked in late 2001 and "trended down through the third quarter as delinquencies were resolved and few new loans were originated."

Retail delinquencies are at 1.73% for the third quarter, but with retail property accounting for more than 30% of outstanding CMBS, the rating agency expects the sector to be a significant influence if conditions worsen. The S&P analysts say, "With consumer confidence falling sharply in October and lackluster September retail sales, this is a sector that needs to be closely monitored." Office delinquencies declined by more than 20% in the third quarter and the delinquency rate in the sector now stands at 0.84%.

The lodging sector saw delinquency rates rising to 6.81% for the third quarter, from 6.69% for the second quarter, in the face of $140 million of lodging loan delinquencies being resolved in the third quarter. S&P reports that "a new crop of specially serviced loans identified by the servicers has been classified as being in imminent default." In this category are 75 hotel loans totaling $646 million. For the second quarter, 38 hotel loans with a principal balance of $195 million were classified thus. And in the multifamily sector, the delinquency rate inched up to 0.76%, from 0.75% for the second quarter. S&P expects multifamily delinquencies to see only a modest rise, but expects several troubled markets, such as Las Vegas, to aggravate the rate.

At the ULI meeting, Kieran Quinn, president of Column Financial, and Ken Rosen, an academic at the Haas School of business in Los Angeles, said that they see a spike in commercial mortgage delinquencies coming. And Fitch Ratings is seeing a more than a 100% increase in the number of defaulted CMBS loans with losses in 2002. Further, the rating agency expects the severity of the losses to increase at least 50%. In comparison, at the end of 2001, CMBS loss severity increased to 34% from 19% as of year-end 2000, Fitch reports.

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