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Rising Commercial Delinquency Rate Could Set 13-Year Record

The commercial mortgage delinquency rate rose to 2.6% in the fourth quarter of 2008 and is expected to surpass 3% this year, which would be the highest level in 13 years. The rise in delinquencies is worrisome in view of the scarcity of credit, and an estimated $160 billion in commercial mortgages coming due in 2009, according to a new report.

“We’re clearly headed into weaker conditions for the economy and for commercial real estate specifically,” says Matt Anderson, a partner in the Oakland, Calif.-based real estate research firm Foresight Analytics, which issued a preliminary report on fourth-quarter delinquency rates. “I’d say by the middle of the year I’d expect a 3% delinquency rate if the conditions we’re seeing out there persist, which we think they will.”

A delinquent loan is at least 30 days past due and still accruing interest, according to Foresight Analytics.

A 3% commercial delinquency rate would be the highest since 1996, but it would remain far lower than the 7.5% registered at year-end 1991. In that period, commercial developers had embarked on massive overbuilding amid the failure of thousands of savings and loan institutions across the country. “I don’t know that [the commercial delinquency rate] will rise to 7.5%, but clearly there’s more distress coming out there for commercial real estate,” says Anderson.

Still, the 2.6% commercial delinquency rate estimated for the fourth quarter of 2008 is significantly lower than the 6.8% Foresight Analytics estimated for residential mortgages. The residential rate rose from 6.4% in the third quarter and 4.2% in the fourth quarter of 2007. But the 30 basis-point leap in the fourth quarter for residential delinquencies was eclipsed by the 50 basis-point jump in commercial delinquencies.

The residential delinquency rate, approaching 7%, is historic, Anderson says. “That’s the highest residential delinquencies have ever been. In the early ’90s, I think they were in the 3% to 4% range, at most. It’s a role reversal this time around. Residential is much higher and commercial is much lower.” But the commercial rate is rising, he adds.

The $160 billion wave of commercial mortgages coming due this year includes whole loans issued by banks, life insurance companies and private equity firms, as well as commercial mortgage-backed securities (CMBS).

However, the figure, based on Federal Reserve statistics, does not include an estimated $50 billion in multifamily loans that also are coming due in 2009. Technically, the Fed’s analysis is classified as “non residential commercial properties,” and the apartment loans, largely backed by Fannie Mae and Freddie Mac, were analyzed separately.

Multiple commercial sectors are feeling the brunt of the economic slowdown and credit crisis. The hotel industry is suffering as fewer travelers hit the road and companies are coping with an increased supply following a burst of new construction over the past several years. Meanwhile, a number of retail companies have gone bankrupt as American consumers cut back on spending — trends that affect the commercial delinquency rate.

With a reported 4.8 million people collecting unemployment benefits, according to the U.S. Bureau of Labor Statistics, the office sector also has been severely affected by layoffs. “Things are looking pretty scary there,” says Anderson.

In particular, a major downturn is expected in oil-producing regions, including Houston. “The jobs figures are still pretty positive there but we think that with the oil price decline during 2009 there will be a big reversal in the Houston market.” The report predicts trouble ahead for New York City and Charlotte, N.C., which have been weakened by losses in the financial sector.

One of the strongest markets, according to Foresight Analytics, is Washington, D.C. With 11.7 million sq. ft. under construction, and positive employment growth of 0.5% in the fourth quarter, and further growth expected under the new Obama administration, Washington remains a healthy location for lending. By contrast, Miami had 3.4 million sq. ft. under construction and negative 2.6% employment growth in the fourth quarter.

Most regions of the country are expected to continue to be affected by lending restrictions and rising delinquency rates. An analysis of commercial mortgage flows in the new Foresight Analytics report shows a dramatic drop in lending by banks, life companies, CMBS and other sources from a peak of $90 billion in the third quarter of 2007 to net zero in the fourth quarter of 2008.

“CMBS mortgage flows, which were as much as half of the commercial market during 2006 and most of 2007, dried up and now have shifted into reverse. They’re actually contributing to a net removal, in that new loans are not being replaced,” says Anderson. “Bit by bit those loans are being removed. The banks and life companies that had been hanging in there and still providing quite a bit of financing — they’ve pulled way back.”

Non-residential construction spending decreased by 19.1% in the fourth quarter, compared with a decrease of 1.7% in the previous quarter, according to the Commerce Department. Meanwhile, the delinquency rate for all existing construction loans, estimated at 11.2% in the fourth quarter, compared with 9.6% in the third quarter of 2008, was far higher than the rates for commercial or residential mortgages. Loans are typically issued periodically throughout a construction project, as a developer demonstrates progress and meets benchmarks that satisfy the requirements of lenders.

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