CMBS Delinquency Rates Highest in a Decade

Commercial Mortgage Backed Security (CMBS) delinquency rates are up by a factor of 3 in the last six months hitting 2.7% in May, which if you’re keeping score, is the highest level in a decade. Additionally there are $155BN of CMBS loans coming due between now and 2012. Of these Deutsche Bank believes about 66.6% won’t qualify for re-financing. The punch was sweet but is the party ending?

Standard & Poors, continues to set the new standard in credit discipline and has recently warned that billions of dollars of top rated CMBS backed bonds could be headed to the downgrade doghouse.

S&P’s actions run counter to the Treasury’s plan to offer low-cost, nonrecourse financing to CMBS buyers as, according to the TALF rules for investors in this asset class, only the highest rated CMBS are eligible.

Timothy Geithner said recently that “this program is critical to restoring the flow of credit to owners of commercial real estate and preventing a damaging chain of events in this market”. Needless to say after the last year and a half we all know what a “damaging chain of events” looks like.

The CMBS market is about $700BN in size but with $230BN of that issued in 2007, the year with the highest issuance on record and probably the lowest lending standards, it would appear that about 1/3rd of the issuance is on less than a solid foundation. For those keeping box scores issuance in 2008 was just $10BN and $0.00 through the end of May of this year.

Under their new guise as concerned corporate citizen and credit watchdog, S&P recently announced changes to the way it rates CMBS’s which would result in a good portion of the “AAA” rated paper synthesized between 2005 and 2007 losing its vaunted rating. In case you haven’t guessed, only AAA paper is allowed in the TALF program. The loans made during said period were extended as a result of “increasingly more aggressive underwriting” standards than in prior years according to S&P.

The CEC Portfolio currently has positions in just four of the 21 names tracked by the Strategy in this sector but all of those are on the short side. The names include: AMB, EQR, HCP and VTR.

The sector, as you might imagine, trades on a pretty highly correlated basis but there are enough differences in the CDS/equity movement of each name that the sector cannot be traded as a block. All of the existing shorts in the REIT sector were profitable as of last night’s close.

CDS spreads bottomed back on June 11th and have risen back to levels seen in mid-May since they’ve turned.

There are many questions now regarding whether the “green shoots” we keep hearing about will get enough of what they need to continue to grow. The commercial real estate market is being used by many as a form of weather radar in hopes of determining whether there are clear skies ahead or storms on the horizon.