Analysis: CRE Mortgage Defaults Tick Up, Setting 16-Year High

The default rate on commercial real estate mortgages held by banks climbed to 3.40 percent in the third quarter of 2009, up from 2.88 percent the quarter before, according to an analysis published on Dec. 1 by Real Estate Econometrics.
In a report on REE's findings, Sam Chandan, the firm's president and chief economist, said the third-quarter default rate marked a 16-year high. In 1993, it hovered around 4 percent. The increase of 52 basis points, or 0.52 percentage points, in the rate is the third-highest jump since 2003.
Chandan also noted that the default rate, which is based on Federal Deposit Insurance Corporation (FDIC) data, has seen an increase of more than 100 percent in the last year. In the third quarter of 2008, defaults stood at 1.37 percent.
REE is projecting that the default rate will hit 4 percent in 2008's fourth quarter and peak above 5 percent in 2011.
"Driving the increase in the default rate into 2011 and 2012—after the economy has resumed a sustained growth trajectory—a large number of loans originated in 2006 and 2007 are unlikely to meet the aggressive cash flow projections embedded in their underwriting assumptions at the point of origination," Chandan said.
Chandan attributed the continued growth in defaults to weakening property cash flow, constrained credit markets and diminishing cash reserves. He also noted that other REE data suggested loan providers are either avoiding new commercial real estate lending or focusing on existing relationships with borrowers.
"Credit standards remain very tight, with the result that even good credit borrowers seeking to refinance seasoned mortgages with healthy loan-to-value and debt service ratios are in many cases unable to secure new financing," he said. "At the same time, the dramatic decline in real economic activity and labor markets since last September has undercut property fundamentals, increasing the number of recently-originated loans that are at risk for delinquency and default because of cash flows' falling short of principal and interest obligations."