Bondholders Bracing for More Commercial Mortgage Defaults

More bad news from the commercial real estate front. Bloomberg reports investors in bonds that packaged $62 billion of debt for U.S. offices, hotels and shopping malls will face more loan defaults through 2010 as Bank of America Merrill Lynch (BAC) says landlords’ monthly payments may jump 20% or more.

From Bloomberg: Principal is coming due on the so-called partial interest-only loans as an 18-month-old recession saps demand for commercial real estate. About $179 billion of such loans were written between 2005 and 2007 and bundled into bonds, according to data from [BofA].

With soaring vacancies and falling rents, some cash-strapped borrowers will fail to cover the higher costs, said Andy Day, a commercial mortgage-backed securities analyst at Morgan Stanley in New York. About 87 percent of mortgages sold as securities in 2007 allowed owners to put off paying principal for several years or until maturity, compared with 48 percent in 2004, Morgan Stanley data show.

“The worst is yet to come,” MetLife Inc. Chief Investment Officer Steven Kandarian a Bloomberg [TV] interview. “Typically there’s a lag between when the economy softens and when the defaults actually occur.”

Investors have already seen prices on top-rated senior debt drop below 70 cents on the dollar from 95 cents a year ago, according to Aaron Bryson, a commercial mortgage-backed securities analyst at Barclays Capital in New York.

Property owners turned to Wall Street to finance office towers, apartment complexes and hotels as banks bundled the debt and sold it to investors. A record $230 billion in commercial mortgage-backed securities were sold in 2007, up from $93.3 billion in 2004, according to Morgan Stanley data. About $750 billion of such debt is outstanding, bank data show.

emphasis added

Just like the housing meltdown, the commercial real estate crunch is starting to slowly but surely exhibit the same symptoms as it spreads evenly across the nation. The reasons for the deterioration are mostly well-known and widely exposed at this point. However, another important and perhaps overlooked aspect of CRE problems is not only the absence of a meaningful risk metric when determining the performance of the underlying real estate collateral, but also – the lack of transparent and robust performance information that has in way, perhaps subconciensly, clauded  investors judgement whe faced with the reality of the quantification aspect in relation to their downside exposure on a go-forward basis.

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