Commercial Realty Loans Keep on Getting Stronger
While debate continues in some quarters about whether the economy has hit a soft patch or not, the performance of commercial mortgages is undisputably getting better on the delinquency and default front. The commercial mortgage loan default scenario for 2004 improved compared to that for 2003, according to Standard & Poor's. And Fitch Ratings saw an overall drop in commercial mortgage-backed securities delinquencies as of the end of April, although the rating agency saw an increase in multifamily and health care-backed delinquencies.
Standard & Poor's reports that as of December 2004, there were 306 more defaults - on 29,827 loans that were originated between 1993 and 2002 and went into CMBS deals rated by S&P - compared to the increase of 404 for 2003. The total number of defaulted loans over a 12-year period, up to last December, was at 1,657 and cumulative default rate on the loans was at 5.56%, S&P said.
Joseph Hu, research head of Standard & Poor's global real estate finance group, co-authored the report with Roy Chun, head of CMBS surveillance for S&P.
Mr. Hu notes, "The 1995-1997 vintages continued to be the worst performers with cumulative default rates of 8.92% to 9.56%, an increase of between 81 and 128 basis points from year-end 2003. Holding seasoning constant, however, the 2000 vintage, now in its fifth year, continued to have the worse cumulative default rate at 6.12%. In contrast, the 2002 vintage with a third-year cumulative default rate of 0.96% outperformed its older vintage counterparts during their third-year seasoning."
As a result of findings from studies that show that "past support levels were excessive," credit support levels for new transactions have been lowered. Mr. Hu said, "Going forward, as long as the loan underwriting standards remain stringent and disciplined, the significantly lowered support levels are expected to adequately protect investment-grade investors."
The default study, which updates two other studies put out by S&P in July 2003 and December 2003, revealed the following:
* Defaulted loans had a "markedly shorter" loan age, larger rate spread (in the case of fixed-rate loans, which accounted for 95% of the studied loans), longer maturity, shorter amortization, smaller principal balance, higher LTV and lower debt service coverage than good loans.
* Loans secured by health care and lodging properties, with cumulative default rates of 16.54% and 22.16%, respectively, continued to substantially underperform the other loan types.
And their cumulative default rates also rose the sharpest in 2004, at 1.64% and 2.23%, respectively.
* Of the 1,657 cumulative defaults, 9% occurred in 2000, 16% in 2001, 20% in 2002, 24% in 2003 and 18% in 2004, reflecting the "deterioration and initial recovery" of the national real estate market over the last economic downturn.
* Of the 865 loans resolved, 577 had principal losses, with an average loss severity of 43.6%, and 288 had no losses.
S&P believes it likely that the credit performance of loans originated in 2003-2004 will be "more resilient" and that they will perform better than the loans of the 1993-2002 vintages.
On the delinquency front, Fitch Ratings said that a loan delinquency index it maintains decreased to 1.20% at the end of April, from 1.22% for March. This is the third decline Fitch has seen over a six-month period. However, Fitch also saw delinquencies in the health care and multifamily sectors rise 10.04% and 8.77%, respectively.
Adam Fox, a Fitch Ratings director, sees the multifamily delinquencies as rising from reduced occupancy and increased market competition. He expects that multifamily occupancy will stabilize as job creation goes up and as the home purchase option becomes more expensive as interest rates rise.
In another sign of improving commercial real estate, and economic, performance, Colliers International reports that absorption in the industrial real estate market totaled 41.5 million square feet for the first quarter - 10 times the 4.1 million square feet absorbed in the first quarter of 2004. "The drivers of the U.S. industrial market have been experiencing vigorous growth, and look likely to maintain this healthy tempo throughout the year," observes Ross Moore, vice president/director of research, Colliers. "Many sectors - including transportation and distribution, manufacturing, retail and housing - continue to post positive results. Consumer spending is also strong. This points toward a direct need for warehouse space. The industrial market shows no signs of waning anytime soon."
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