As expected, the delinquency rate on CMBS conduit deals has gone up in January, according to a recent report by Merrill Lynch.

The uptick that was seen over the last month is part of a continuing trend that heated up post-Sept 11. According to the report, delinquency rates have skyrocketed by 50% since September. However, Merrill said that the significant spike in delinquency rates post-WTC was not a surprise.

The 60+ delinquency rate - analysts used this measure because the 30-day measure can be "very volatile" - for the entire conduit universe, which amounts to roughly $164 billion, went up to 1.20% in January from 1.11% in December. Though the nine-basis-point rise was somewhat muted compared to the two previous reporting periods, analysts still consider this significant.

Several causes

In an earlier publication, analysts from Merrill said that that they expected delinquency rates to rise above the trend line and to go above the 2.5% level during the next year.

The continued uptick could be attributed to two factors: the aging or seasoning of CMBS loans and the current economic and real estate problems. According to Roger Lehman, director of mortgage research at Merrill, even without an economic downturn they still would have expected delinquencies to be trending up this year. However, it would have been at a much slower rate if it were only due to the seasoning of loans.

The report also presented a breakdown of delinquency rates for the entire CMBS universe by property type. The hotel sector, which has become the usual suspect of late, showed the most delinquencies.

"We have been wary of the hotel sector for a number of months and the delinquency statistics demonstrate that our caution was warranted," wrote analysts.

The report stated that without the 48-basis-point rise in hotel delinquency rates, the rates for the entire CMBS universe would have remained unchanged. Aside from hotels, retail emerged as the next biggest" real estate trouble spot."

Not a big threat to CMBS

Though the rise in delinquencies will make downgrades more prevalent than they have been in the past, they will not be a major threat to CMBS investment-grade tranches. Merrill's Lehman said that the subordination levels on these are high enough to protect the market from the target level of delinquencies.

"It is important to point out that stress environments worse than the current one have been factored into the rating agency approach and subordination levels so the highest-rated tranches have more than adequate protection," said Lehman.

However, the lowest-rated tranches in CMBS will certainly take losses, although these have been built into their pricing; the buyers of these bonds have purchased them with expected losses in mind.

Lehman also pointed out that delinquent loans do not always result in a loss. Some of these loans can actually become current again and some of them may even pay-off in full.

Fitch report on

rising delinquencies

Fitch Ratings has also highlighted the trend in its recent real estate update. According to the rating agency, delinquencies rose to 1.11% in 334 Fitch-rated transactions from 1.03% in November and 0.93% in October. Fitch calculated the delinquencies based on the balance of loans 60 or more days delinquent, which incorporates both foreclosure and real-estate owned loans.

"This trend of increasing delinquencies is not surprising and is expected to continue as slow economic conditions continue to affect the real estate market," said the analysts.

They stated, however, that these rates are not likely to reach the almost 7% peak level reached in the American Council of Life Insurers data from early 1992.

Fitch's findings are consistent with Merrill's in terms of the sector breakdown, as analysts found both hotel and retail to have been especially hit hard by present economic conditions.

December figures show that these two sectors make up 52% of total delinquencies. However, there was a shift in percentages that started in the third quarter of last year.

Hotel loans have increased their share in the total number of delinquencies from 15% (this is data as of the third quarter) to 24%. Retail loans, on the other hand, have gone down to 27% from 35%.

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