CMBS deliquencies to have negligible impact on capital markets liquidity

Recent reports on the health of the U.S. commercial mortgage-backed securities market, and specifically ascertaining loan delinquency rates, vary in their findings. CMBS issuance is certainly at a high, though delinquencies from established loans are up or down, depending on the source. It is clear that Florida is among the highest states for CMBS delinquencies, in large part because of its reliance on the volatile hotel industry.

Delinquency rates in CMBS can affect commercial real estate financing terms and investor perception, though to what degree it will affect loans in the near future is arguable. Steve Nostrand, director of mortgage and investment banking at Codina Realty Services in Coral Gables, says that the term "delinquency" itself is often misconstrued.

"[Delinquency] often means that there is a wait-to-pay, and the loan may go into a special service situation," Nostrand says. "That's not a loss, and that's not a foreclosure."

Nostrand believes that delinquencies are "a minor blip on the screen," particularly when compared with the estimated 27% rise in CMBS issuance the first quarter of 2004 compared with last year.

CMBS issuance in the U.S. capital markets during the first quarter of 2004 totaled almost $19 billion from $15 billion -- or 27% -- from the same period last year, according to the Washington, D.C.-based Urban Land Institute (ULI) in its May 2004 report. Data aggregated by ULI shows that during 1Q 2004, overall CMBS delinquencies declined 0.13% from 1.62% to 1.49%, 30/60/90 day delinquencies declined 0.15%, though foreclosures increased 0.02% from 0.15%.

ULI notes that the CMBS market strength is evidenced by the pricing on April 30 of a $2.6 billion offering, the largest in recent history, but points out that the likelihood of higher interest rates will affect perceived conditions for investors, most significantly in the suburban office sector and industrial research and development.

According to a report co-authored by Horsham, Penn.-based Frank Innuarato, vice president and senior analyst at Realpoint Research/GMAC Institutional Advisors, the delinquency rate for CMBS increased to 1.57% in February -- its highest level since July 2003. CMBS delinquency reached $5.71 billion in February, compared with $4.46 billion in March 2003.

"We predicted that through the first quarter 2005, we expect delinquencies to reach somewhere in the six billion dollar range," Innuarato says. "We don't expect that to grow at an alarming rate ... It's part of the natural cycle."

The Realpoint report analyzes $363.4 billion in CMBS from January 2001 through February 2004.

Realpoint found over 86% of CMBS delinquency -- by deal type -- in fusion and conduit deals. The report also indicates that deals in 1998 and 1997 make up nearly 48% of the total delinquency, or 0.75% of all CMBS, and the trend is increasing. By issuance year, the highest ratio of delinquency at 6.5% is from deals that remain from 1995.

Standard & Poors (S&P) published an April 28 report stating that the delinquency rate for S&P rated U.S. CMBS declined in the first quarter by 0.19% from the previous quarter, ending up at 1.77%. S&P reports that CMBS delinquencies in the first quarter totaled $3.979 billion on a base of $224.200 billion, compared with $3.970 billion at the end of 2003.

S&P states that "dramatic decreases" in new delinquencies in the first quarter, rather than resolution of loans, caused the delinquency rate to decrease. Loan resolutions have remained stable, but actual loan loss was relatively high at 42.33% of loans in the resolution process, compared with the 10-year loss rate of 28.50%. S&P notes that this is close to last year's 41.07%. Loan loss included all loans delinquent at the beginning of the quarter that borrowers paid-off or liquidated.

The report indicates that the office segment experienced the most significant rise in delinquency rate in the first quarter, with a 12% increase in the amount delinquent, compared with the 0.21% increase for all the other property types combined. The report notes that the office sector is closely tied with employment growth. Office vacancy rates are expected to decline this year.

S&P calculated a 7.28% delinquency rate for the lodging sector in the first quarter, totaling $1.21 billion, compared with 7.78% at the end of 2003 (and a high 8.37% in June 2003). Lodging loan resolutions in the first quarter brought about the drop. Of the resolved lodging delinquencies, 14 loans paid off without loss and 12 experienced losses. The report notes that, significantly, Orlando experienced no new lodging delinquencies in the first quarter, compared with shortly following 9/11 when Orlando lodging accounted for approximately 25% of all S&P's CMBS lodging delinquencies. Currently, delinquent Orlando lodging accounts for about 11% of all lodging delinquencies and is benefiting from the increase in leisure travel.

The Realpoint report indicates that hotel and retail collateral were the poorest performers, accounting for 0.71% of all CMBS unpaid balance. Hotel delinquency actually dropped 15% over the past year, but it still accounts for nearly 5% of all hotel loans in CMBS, nearly five times higher than any other asset type.

Florida and Texas show the highest levels of delinquencies, swapping first place over the past few months. Realpoint states that hotels account for about 46% of Florida's CMBS delinquencies.

Christian Charre, vice president at Jones Lang LaSalle Hotels in Miami, replies that Orlando is the second largest U.S. hotel market with many properties financed through CMBS, and that the vulnerability of the hotel industry to any type of economic downturn or crisis will certainly take its toll.

"After September 11, we had Afghanistan, then Iraq, then SARS and throughout 2003 a jobless recovery," Charre states. "All these factors took its toll in the hotel industry with corporations curtailing corporate travel and an increase of people out of work during this period."

However, Charre says that the hotel industry is rebounding, particularly in South Florida, with an increase in revenue per available room (RevPAR) of more than 13% in the first quarter. While hotels may be rebounding, many hotels are still struggling to keep current. Charre says that because CMBS loans are packaged and sold in the secondary market, often hotels do not have the flexibility to renegotiate their loans. The loan therefore falls into default and a special servicer may take over, which often sells the property or puts new management in place.

Charre believes that the hotel industry is continuing to gain strength.

"With the improving economic environment and a healthy gain in terms of ADR (average daily rate) and occupancy, the sector is on a rebound and delinquencies should taper off in the coming months," Charre states.

Overall, Nostrand says that the variations in CMBS data prove the good health of the CMBS industry.

"It has strength and depth, and continues to be one of the most efficient sources of commercial real estate capital," Nostrand says.