Commercial-mortgage crunch reach $1 trillion

Thursday, April 23, 2009 at 11:26pm
Sarah Mulholland, Bloomberg News
office towers.jpg

Loan extensions will likely be insufficient to prevent a wave of commercial real-estate defaults as borrowers struggle to refinance debt amid tighter lending standards and plummeting property values, according to Deutsche Bank AG analysts.

As much as $1 trillion in commercial mortgages maturing during the next decade will be unable to secure financing without significant cash injections from property owners, according to the Deutsche analysts. At least two-thirds, or $410 billion, of commercial mortgages bundled and sold as bonds coming due between 2009 and 2018 will need additional cash infusions to refinance, the analysts led by Richard Parkus in New York said in a report Wednesday.

Many commercial real-estate borrowers will be unwilling or unable to put additional equity into the properties, and will have to negotiate to extend the loan or walk away from the property, the analysts said. The volume of potentially troubled loans and declining real-estate values will make loan extensions harder to obtain.

“The scale of this issue is virtually unprecedented in commercial real estate, and its impact is likely to dominate the industry for the better part of a decade,” the analysts said.

The gap, or spread, on debt backed by commercial mortgages has soared relative to benchmark interest rates amid concerns about rising defaults. Top-rated debt is currently trading at about 8.7 percentage points more than benchmark interest rates, compared with less than 1.7 percentage points a year ago, Bank of America Corp. data show.

Fed expanding its efforts

The Federal Reserve last month expanded its $1 trillion program to finance the purchase of assets clogging bank balance sheets to include securities backed by commercial mortgages. Spreads on the debt have narrowed 3.6 percentage points since the Fed said it would include the debt.

Many dismiss the seriousness of the problem by assuming lenders will agree to extend maturities, according to the report. That approach might work if the amount of loans that failed to refinance was relatively small, but the percentage is likely to be 60 to 70 percent, the analysts said.

The overhang of distressed real estate will hinder price appreciation, making lenders less likely to extend mortgages with the expectation that the value of the property will rise enough to qualify for refinancing, the analysts said.

Loans made in 2007 when prices peaked and underwriting standards bottomed will face the biggest hurdles to refinancing. Roughly 80 percent of commercial mortgages packaged into bonds in 2007 wouldn’t qualify for refinancing, according to Deutsche data.

Those counting on extensions to provide relief in securitized commercial mortgages may be in for a “rude awakening,” the report said. Investors who hold top-rated AAA bonds backed by commercial real estate have begun to mobilize against a move that would grant more flexibility to servicers looking to extend loans, the analysts noted.

Holders of top-rated bonds might prefer to see the property foreclosed sooner rather than later, as they are the first to get paid off when a property is sold.