Defaults on commercial mortgage-backed securities (CMBS) will triple this year to an all-time high, according to recent reports by Fitch Ratings and Standard and Poor's.
CMBS defaults will reach 3 percent by year-end, the highest default ratio in the history of the market, double the previous high of 1.5 percent set in 2003, according to Fitch. Standard & Poor's sets the bar even higher, saying it could reach 3.5 percent by year-end.
CMBS defaults reached 1.15 percent at the end of January, a dramatic rise from the 0.43 percent default rate of September 2008. About 40 percent of those defaults are multifamily loans, according to Fitch, though multifamily comprises only about 30 percent of the U.S. CMBS industry.
In January, three large CMBS loans that were originated in 2007 pushed the default rate above 1 percent. Two of the three were multifamily loans—the $225 million loan secured by Riverton Apartments in New York City, and a $130 million pool consisting of 2,900 units located in Virginia, Georgia, and North Carolina.
Yet the majority of multifamily defaults are occurring on smaller, older properties by small-company borrowers. Canadian ratings agency DBRS notes that of the $3.2 billion in fixed-rate multifamily CMBS in default in the United States, $2.2 billion are smaller loans (under $25 million and averaging about $7 million).
While many multifamily REITs tapped the CMBS market in its heyday, "the loans that are in default at the moment are not necessarily those borrowers," says Susan Merrick, a managing director at Fitch. "A lot of the multifamily defaults are smaller properties, and the borrowers are generally single-property owners and not as experienced, generally."
Multifamily CMBS loans are having the hardest time in Florida, Michigan, Arizona, Nevada, and California—the states hardest hit by the single-family meltdown. Multifamily CMBS loans in these states have a default rate of 4.1 percent, the highest of any property type and more than 20 percent above the national average, according to Fitch.
Across the country, defaults of fixed-rate CMBS loans increased 17 percent in February over January, bringing the default rate of fixed-rate CMBS to 1.21 percent, according to Erin Stafford, a senior vice president at DBRS.
"If it keeps going at that rate, it will definitely hit 3 percent by the end of the year," Stafford says. She notes that the default numbers would be even higher if figuring in loans on the verge of default that were voluntarily transferred to special servicing by borrowers giving an early heads-up to lenders about their inability to pay next month's coupon.
All of the recent trend lines have been severe and negative. Since the fourth quarter of 2008, about 70 percent of 30-day delinquencies are becoming 60-day delinquencies. "In earlier 2008, it was more 30 percent to 40 percent on average," says Eric Rothfeld, managing director at Fitch. "There's certainly a trend of that percentage increasing substantially beginning in the fourth quarter."
At the end of January, about $1.7 billion in CMBS loans were 30-days delinquent, and if all of those rolled to 60 days, the default rate today would be about 1.5 percent, according to Fitch.
Fitch is forecasting total U.S. CMBS issuances to be about $12 billion in 2009, with most of it coming in the second half, a stark contrast to the record $230 billion issued in 2007.
Somewhere in between those figures lies the market's sweet spot. "Prior to 2004, what had been done was around $80 billion or so, and that seems to be a very viable market," Stafford says. "If it returns to a $50 billion to $100 billion market going forward, that would be fine."