CMBS Market Begins to Show Fissures

The market for debt used to finance hotels, offices and shopping malls tumbled Tuesday on worries that the long-feared rise in defaults for commercial mortgage-backed securities had begun, possibly ushering in the next phase of the financial crisis. Analysts at Credit Suisse said two big commercial mortgages that had been packaged into securities in the past year were likely to default. The rapid deterioration of these loans fed worries that the weakening economy and higher unemployment rate would drag down the $800 billion market for commercial-mortgage-backed securities, or CMBS, which so far has withstood the credit crisis with low delinquency rates. "It's pretty unheard-of for two large loans to go bad this early on," said Richard Parkus, head of CMBS research at Deutsche Bank Securities Inc. "This has shaken up the market" for CMBS, he said. The analyst report pushed the index that tracks these securities, the Markit CMBX, to record levels compared with Treasurys. The news comes as defaults on commercial mortgages are starting to rise. According to a Citigroup Inc. report, the overall number of commercial mortgages packaged into securities that are 30 days or more past due rose to 0.64% in October from 0.39% at the end of last year, with most of the increase coming in October. The latest figure, though low by historic standards, marked the highest delinquency rate in two years. The jump in soured commercial loans was mainly due to the financing drought and a lack of buyers. Property owners have been unable to refinance mortgages as they have become due, forcing defaults if existing lenders have been unwilling to extend loans under the same terms. The loans that sent the market down Tuesday were worrisome because they were made at what it now looks like was the top of the real-estate market and were based on assumptions that the cash generated by the properties would rise. Both loans were made by J.P. Morgan Chase & Co.: a $209 million mortgage backed by two Westin hotels in Tucson, Ariz., and Hilton Head, S.C., and a $125 million loan secured by a retail center, called Promenade Shops at Dos Lagos, in Corona, Calif. The Westin loan, which J.P. Morgan made in December, projected a $23.7 million annual cash flow for the property, 13% higher than what it was at the time. The loan represented about 70% of the purchase price of the property. An official at the borrower, Transwest in Tucson, declined to comment. When the Promenade loan was made in July 2007, the property's cash flow was $6.3 million, but J.P. Morgan underwrote it on the assumption it would rise to about $10.5 million. About $8.8 million in reserves were set up when the loan was made. The reserves, intended to cover certain expenses, are down to about $2.8 million today. "The depressed housing market in the San Bernardino Valley led to lower sales for our retail and other tenants," said Josh Poag, chief operating officer at Poag & McEwen Lifestyle Centers in Nashville, Tenn., which owns the Promenade property.