Default Rate for Bank-Held Commercial Mortgages Increases: Real Estate Econometrics
12/01/2009 By: Brittany Dunn
In the most recent report by New York-based Real Estate Econometrics (reeconometrics), the property research firm updated its projections, predicting the default rate for bank-held commercial mortgages will rise to 4.0 percent by the end of 2009 and will peak in 2011. Due to higher concentrations in commercial real estate, the largest losses are expected to occur at regional and community banks with $100 million to $1 billion in assets.
Up from 2.88 percent during the second quarter, the national default rate for commercial real estate mortgages held by depository institutions increased to a 16-year high of 3.40 percent during the third quarter of 2009, according to reeconometrics’ analysis of data reported by regulated lenders and published by the FederalDeposit Insurance Corporation (FDIC). This 52 basis point rise in the default rate was the largest one-quarter increase since quarterly data became available in 2003. The total balance of defaulted commercial mortgages increased 14.0 percent, from $44.1 billion in the second quarter to $50.3 billion during this year’s third quarter.
During this same period, the multifamily mortgage default rate grew 44 basis points, increasing to 3.58 percent from 3.14 percent. During the past year, the default rate on multifamily mortgages has more than doubled, rising by 211 basis points from 1.47 percent in the third quarter of 2008. In the multifamily sector, the balance of delinquent and defaulted mortgages increased by 9.8 percent from $9.3 billion in the second quarter to $10.2 billion during the third quarter of 2009.
A variety of factors have contributed to the rise in commercial and multifamily delinquency and default rates, reeconometrics said. Rising vacancy rates, falling asking and effective rents, and rising operating expenses have created deterioration in property cash flow resulting in an increase in the number of borrowers that are unable to meet current principal and interest obligations. Additionally, the erosion of reserves available to cover shortfalls in debt service coverage and constraints on the availability of credit to support the refinancing of maturing mortgages have contributed to this rise in rates.
As a result of the large number of mortgages underwritten to aggressively-forecast prospective cash flow rather than to in-place cash flow during 2006 and 2007, mortgages originated during this period are experiencing the most significant shortfalls in current cash flow relative to current debt service obligations. These loans are unlikely to meet the aggressive cash flow projections embedded in their underwriting assumptions at the point of origination, driving the increase in the default rate into 2011 and 2012, the report said.
According to reeconometrics, banks with similar concentrations in commercial real estate may exhibit marked differences in delinquency and default rates. Through an analysis of loan performance at the 5,015 institutions with the largest exposures to commercial real estate, no statistically significant relationship between concentration and default rate were shown. However, the report found that default rates are higher for institutions in larger asset size groups. While institutions with $10 billion or more in assets have significantly lower commercial real estate concentrations, they also exhibit higher default rates at the mean and across the distribution. The median default rate at the largest institutions is 2.7 percent, as compared to 1.4 percent across the broader pool.
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