Commercial Mortgages Are Landing in the Ditch

Delinquencies are way up. Loans are way down. Credit is as tight as it can be. Lots of people want to refi but are finding it hard. News headlines for residential originators? Actually, no. The mortgage disaster, while not yet over on the residential side, has come home with a vengeance to the commercial mortgage side.

New figures released by the Mortgage Bankers Association reveal that commercial/multifamily mortgage delinquencies continued to boom during the first quarter of 2009. In fact, the MBA pointed out that delinquency rates have been higher than any time since 2001. Added to that, there's been virtually no issuance in this sector and the origination of new commercial mortgage loans has come to a grinding halt. The question now is, how bad are things going to get for CRE, and when can we expect to see any sort of recovery? In terms of where the commercial lending industry is now, according to the MBA, the 30-plus day delinquency rate on loans held in CMBS went up 68 basis points to 1.85% between the fourth quarter of 2008 and first quarter of 2009.

The 60-plus day delinquency rate on loans held in life insurance company portfolios, where the balance sheets have been squeaky clean for many years, went up 5 basis points to 0.12%. The 60-plus day delinquency rate on multifamily loans held or insured by Fannie Mae rose 4 bps to 0.34%. The 90-plus day delinquency rate on multifamily loans held or insured by Freddie Mac rose 8 bps to 0.09%. The 90-plus day delinquency rate on loans held by FDIC-insured banks and thrifts rose 66 bps to 2.28%.

"Delinquency rates on commercial and multifamily mortgages held by banks and thrifts, by Fannie Mae and in commercial mortgage-backed securities are all now at levels higher than at any time since the 2001 recession," said Jamie Woodwell, vice president of commercial real estate research at the MBA.

"It's going to vary by market, but here in California with the budgetary problems, increasing unemployment and housing crisis, you can expect to see marked increases in CRE vacancies," said Walter J Mix III, a managing director at the global consulting firm LECG LLC.

Susan Merrick, managing director at Fitch Ratings and head of its U.S. CMBS group said: "it's too early to tell" how bad it's going to get. Delinquency rates, according to Ms. Merrick, started from an incredibly low base and are still relatively low (under 2%), but pointed out that "they're continuing to increase, but they're rising from 2006, 2007 vintages."

Mr. Mix also pointed out that, with the CMBS market now nonexistent, the sources for a large refi need that will rise over the next two years are now limited."The amount that's going to need to be refied in the next two years is about $1.5 trillion," he said. "Many of these loans were made at the time when we had low cap rates and low vacancy rates. Now, we have cap rates reverting to the mean and vacancy rates that seem to go higher every day."

Ms. Merrick said that we're currently seeing "a stalled market," with most parties involved unsure as to how to proceed. "Everyone knows there's been a decline in values, but there's still a big gap between what buyers are willing to buy at and what sellers are willing to sell at, so there's still a disconnect between what the perceived value is."

In terms of which sectors in the commercial real estate market are hurting the most, Ms. Merrick said that Fitch thinks the hotel sector will see the most damage. "With a distressed consumer and high unemployment, leisure travel is down considerably. And with companies contracting and making budgetary cuts, business travel is down considerably as well. That won't increase until you see corporate profits increase and until you see companies start hiring again."

Multifamily, according to Ms. Merrick, will most likely be the most stable sector. Also, since office leases are in general given for longer terms, the office sector also has some stability. However, in addition to the hotel industry, the retail sector may also see some trouble, as there have been a number of retailers of all different shapes and sizes that have either gone out of business or retrenched.

Mr. Mix said that shopping centers and anything in the retail center are the sectors he's seeing face the biggest challenges, particularly in California. The industrial sector, according to Mr. Mix, seems to be holding up better. "Anything that's further out from the core business areas seems to have the most challenges," he said.

Mr. Woodwell added that delinquency rates on commercial mortgages held by life insurance companies during 1Q09 remained below the 2001 recession levels. So when can the market expect to see a recovery?

According to Ms. Merrick, there will clearly be a recovery; it's just difficult to gauge when. "That's what all the government stimulus programs are trying to do: restart the lending market," she said. "If you've restarted the lending market, you'll be able to refi a purchase or refi a loan. Right now there's really no activity on the capital market side."

"I think it depends on how the private sector and government create a solution to this void in the market," said Mr. Mix. "There needs to be a proactive approach."

Mr. Mix also stressed that banks need to "give a fresh look at their CRE portfolios," adding that banks need to get new appraisals, begin discussions with the borrowers to attempt to remove any outliers from the portfolio and raise capital as needed.