BLOG VIEW: Checking On The Other Shoe

Attention commercial mortgage professionals: The sky is falling. Or maybe it isn't.

National coverage of the still-unfolding mortgage crisis has recently included a wave of analyses addressing whether or not a few recent high-profile commercial mortgage defaults, coupled with sinister signals from the economy, indicate a forthcoming genuine crisis in this still-standing section of the mortgage industry. The phrase ‘next shoe to drop’ has begun appearing with alarming frequency.

First, although fresh CMBS issuance has been essentially nonexistent for quite some time now, the imminent damage potential of existing CMBS has recently grabbed a few headlines. For the big-name global banks, including Citigroup, Merrill Lynch & Co. and Barclays PLC, falling values and soaring interest rates on even the top-grade securities are expected to markedly wound portfolios.

Write-downs stemming from disastrous subprime residential mortgage investments? So last quarter. For the fourth quarter of 2008, CMBS write-downs and losses will deliver the dominant financial blow, Dow Jones recently reported.

‘The banks hold these assets separately from their traditional loans, which banks typically hold to maturity,’ the article notes. ‘That means the firms must generally adjust the values of these nontraditional assets to reflect current values – hence the specter of write-downs.’

As we have seen over the past several months, gaping losses for major financial institutions are not without global economic ramifications. Fortunately, however, CMBS-related losses are generally expected to be less severe than those experienced by the banks earlier this year.

Moreover, actual commercial loan delinquency figures – for mortgages held in CMBS securities, as well as those stowed elsewhere – remain low. According the latest research from the Mortgage Bankers Association, despite another quarter-over-quarter delinquency uptick among all investor groups examined, third-quarter data portray a sky mostly in placeâ�¦ for now.

The 30-day delinquency rate on CMBS loans rose to 0.63% – an increase of 0.10 percentage points. The 60-day delinquency rate on loans in life company portfolios increased 0.03 percentage points to 0.06 percent, and the delinquency rate for loans held by FDIC-insured banks and thrifts climbed to 1.38%.

According to a recent New York Times article, those days of still-low delinquency are numbered. ‘Defaults on mortgages are a trickle right now, but the pace will pick up over the next year, more than I would have thought in October,’ Mike Kirby, a principal at Green Street Advisors, told the newspaper. ‘It's coming, and it can't be avoided. There's going to be a lot of it, and it's going to be bad.’

Still, until those hits happen, some industry figures would still prefer that we avoid exaggerating them – or even mentioning them.

‘I wish the media would stop writing about commercial real estate defaults, because it spooks lenders and investors,’ writes real estate entrepreneur and author Jim Randel in a recent column.

He outlines several fundamental arguments supporting the idea that while a few commercial mortgages may come slightly unlaced, the sector's newly popular status as the next shoe to drop is entirely unwarranted.

For starters, unlike starry-eyed new homeowners, commercial real estate investors go forth with their transactions based only on hard numbers – never emotion, he says, and originators, likewise, never bent basic financing rules as drastically as their doc-light counterparts in residential. Ample reserves and anti-walkaway measures also differentiate commercial property investors from home buyers.

Ultimately, will those safeguards be enough? Randel's readers think not.

‘I am not sure there is a big difference in letting emotion drive a purchase, or an Excel spreadsheet that has flawed assumptions,’ one commenter writes. ‘I might be inclined to take the emotional buy over a deal that never loses in Excel.’

‘You might have a little too much faith in this investor class that is all brains and no emotions,’ posts another. ‘Isn't that what we were led to believe about 'the smartest guys in the room' over at Goldman Sachs, which leveraged itself to about 35-1?’

‘Greed is also an emotion,’ the reader continues. ‘Remember those stoical smarties with monikers like Merrill Lynch, Lehman Brothers, Bear Stearns? And as for point #4 in your article… Reserves? Those went out of fashion among the financial genius class about a decade ago.’

– Jessica Lillian, Commercial Mortgage Insight


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