The pile-up that is the CRE lending market is just beginning to reveal itself.
Unlike resi-mortgages, which hopefully are approaching Camp O'Donnell on the final legs of their death march toward consumer capitulation, commercial mortgages have just recently left Bataan. [sorry, insensitive reference - apologies in advance]
TILB recently came across a great graph that showed 60+ day delinquencies* for loans in CMBS by aggregate annual collateral vintage beginning in 2003 (this includes the vast majority of outstanding loans underlying CMBS). The X-axis shows the number of months since issuance and the Y-axis shows percentage of loans from that vintage that were 60+ days delinquent. See below for the graph.
Historically a graph like this would start out low and flat, trending up ever so slightly. Beginning in month 60 (year five), we'd see a spike up and then back down after the first set of maturities passed (forming a hump). The same would occur around month 84 (year seven) and so on. If well underwritten, each vintage should behave about the same. Certainly no vintage would show a meaningful spike beginning in month 16 (for 2007 vintage), 28 (for 2006) or 40 (2005). But that is precisely what the graph shows. And these upticks are not the beginning of humps; they are the beginning of rockets that have basically gone vertical.
As fascinating as those 2005-2007 vintages are (and they are indicating an astoundingly bad future), we find 2004 to be the most informative because that vintage has just hit its first round of maturities (5 year balloons). Perhaps it represents the proverbial canary?
Let us dig.
For 2004-vintage loans included in CMBS, 24% of those maturing in 2009 are 60+ days delinquent versus less than 2% for those maturing later. Read that again: 24% of all 2004 CRE mortgages packaged in CMBS that are maturing in 2009 are already 60+ delinquent. That's not 24% of all 2004 loans that already have matured in 2009, it's 24% of loans that already have or will mature in 2009 are 60+. 24% through May!?!?
By the end of 2009, this may very well be 40%+ as the five year loans underwritten in the second half of 2004 (and thus ballooning in 2H09) were written just as asset values seemed to take off and lending standards loosened. In fact, according to NCREIF's website, cap rates were still 7%+ for most of 2004, basically in the middle innings of the fateful cap rate plunge to nearly 5%.
In 2004, a few conservative folks thought CRE was getting a bit frothy, though for the most part underwriting standards were still reasonable (at least compared to the 2005 - 1H2008 period). Basically we are saying that the 2004 vintage is failing despite not being astoundingly "toxic". Underwriting standards and the valuations used to support them became progressively more "flexible" every year thereafter.
CMBS Delinquency Graph - May 2009
If the commercial mortgage delinquencies experienced so far in 2009 worry you, just wait until next year (2010) when the aggressively underwritten 2005 vintage has maturities, then 2011 when the 2004 seven year maturities and the egregious 2006 five year wave hits!
Every time you think the last car has hit the pile-up, just think about the ensuing year.
2012 is unfathomably bad: seven year maturities from 2005 originations and five year from 2007; two truly toxic vintages have big resets together.
TILB's personal view is that the way banks and insurance companies try to "solve" this nightmare is by extending maturities in exchange for some amount of new equity injection, tighter covenants and a new rate. This will not be practical in many situations, but it will occasionally be accomplished. This is not an act of charity; it will be their attempt at postponing the recognition of and provision for bad loans. Securitizations will probably be more aggressive in dealing with problem loans now which will keep pressure on CRE prices, preventing recovery.
In any case, as banks and insurers extend, it will have a suffocating effect on new lending as these loans will continue to eat balance sheet capacity for lending institutions (and new securitization will remain dormant). This lack of fresh lending capacity will obliterate CRE valuations for obvious reasons.
Watch what happens in two or three years when these postponed problem loans come due at the same time that two major maturity waves from problem vintages hit: a shitstorm of Texas sized proportions.
We look forward to watching Geithner and Bernanke somehow argue that Wells Fargo/Wachovia, Bank of America and the regional banks, which have just begun digesting these trends, are well capitalized. The ultimate losses lenders absorb will be astounding.
As a self aggrandizing aside, here's a brief reminder from TILB's annual Prediction and Surprises we wrote in late December and posted this past January (#3 and #6 in particular):
3) Housing prices cross the -30% peak to trough level (Case Shiller 20-city index). Commercial real estate becomes the watchword as housing price declines begin to slow toward the end of 2009.As the creator of the above graph noted, the only green shoot we are seeing is the vertical green line on the 2004 vintage mortgages.
6) The credit crisis is not arrested. After having rolled through housing, it begins its attack on commercial and corporate in force. The default rate for HY approaches double digits but bank debt only makes it to mid single digits (5-7%), so far. As I predicted a few years ago, the default wave continues to roll through credit sub-classes. While it was initially in subprime, which had the nearest resets and the lowest quality borrowers and collateral, we see it move into Option ARMs as people begin to reach 115% of their initial balance due to minimum payments and some 3/1 and 4/1 ARMs from the more toxic vintages of 06 and 05 hit resets. New CRE (commercial real estate) financing is unavailable at attractive interest rates and cap rates climb near double digits. That said, the CRE default wave only begins to pick up modest steam in 09 as the 5/25 balloons from 2004 and early 2005 approach or cross through their reset periods. Covenant-lite LBO debt performs horribly, but due to a lack of covenants, the defaults are really a 2010 and beyond phenomenon. Because each of these huge credit asset sub-classes really have staggered aggregate maturities, the credit crisis has trouble getting past us (subprime 2007-08, option ARM 2008-09, jumbo prime 2009-10, CRE 2009-14, full covenant bank debt 2009-10, HY 2009-11, muni 2010-11, cov-lite bank debt 2010-12). All flavors of credit are obviously correlated as the companies and institutions that provide the loans are the same for all kinds of credit and this continues to drive availability of credit down and the price of and standards for credit up. This adjustment hurts many people.
* 60+ days delinquency generally indicates serious delinquency (whereas 30+ includes folks that may simply have foot faulted).
