Commercial Mortgage Defaults Jump for U.S. Banks (Update2)

By Hui-yong Yu

Aug. 31 (Bloomberg) -- The default rate on commercial mortgages held by U.S. banks more than doubled in the second quarter from a year earlier amid falling rents and occupancies for malls, office buildings and warehouses.

Loans that were 90 days or more past due climbed to 2.88 percent of outstanding balances in the second quarter, from 1.18 percent a year earlier, according to New York-based property research firm Real Estate Econometrics LLC. Defaults increased from 2.25 percent in the first quarter.

“A delinquency may have resolved itself two years ago,” said Real Estate Econometrics President and Chief Economist Sam Chandan. “Today, even one missed payment may be more indicative of an underlying problem, so banks have to be very proactive in addressing the issue.”

Banks held $1.087 trillion of commercial property loans in the quarter, up from $1.077 trillion in the previous three months. That’s almost 15 percent of all loans and leases held by banks, Real Estate Econometrics said. Defaults are rising both for lenders who hold commercial mortgages and for bondholders in the $700 billion U.S. market for securities backed by commercial mortgages.

The CMBS market accounts for about 22 percent of the nation’s $3.4 trillion in commercial real estate debt, according to the Real Estate Roundtable. Defaults and late payments on loans bundled into CMBS could surpass 7 percent by the end of this year, research firm Reis Inc. said on July 30.

Falling Behind

Banks are beginning to recognize that more past due commercial property loans are unlikely to be paid in full. Commercial mortgages labeled as “non-accrual” more than doubled in the second quarter from a year earlier, to $27.76 billion, according to Real Estate Econometrics. The figure reflected a 31 percent increase from the previous three months.

Commercial defaults will rise to 4.1 percent by year’s end, a rate last seen in 1993, according to Chandan’s forecast. Overdue commercial property loans reached 4.6 percent in 1992 during the savings and loan crisis, when the U.S. created the Resolution Trust Corp. to sell off real estate and non- performing mortgages held by insolvent lenders.

This year’s first-quarter default rate was the highest since 1994, Real Econometrics said.

The credit crisis and recession mean lower occupancies and rents for apartment buildings, offices, shopping malls, warehouses and hotels.

Apartment Defaults

U.S. apartment vacancies may rise to 7.8 percent by the end of this year and break the record 8 percent in 2010 as unemployment worsens and the supply of new apartments increases, according to New York-based Reis.

The default rate on bank-held mortgages for apartment buildings climbed to 3.13 percent in the second quarter from 1.20 percent a year earlier, according to Real Estate Econometrics.

A loan is delinquent when it’s 30 to 89 days past due and in default when 90 or more days late.

To contact the reporter on this story: Hui-yong Yu in Seattle at hyu@bloomberg.net

Last Updated: August 31, 2009 16:04 EDT