Rating agency Standard & Poors said that new issuance of commercial backed mortgage securities this year would be very limited as the spectre of loan defaults increases.

It said in a report published today that further deterioration in loan performance following a 10-year run of almost no loan defaults in European CMBS appears inevitable, as economies weaken and the dislocation in credit markets continues.

In 2008, 48 tranches of CMBS debt rated by S&P were downgraded for credit reasons, compared to 14 tranches in 2007. It said this number would increase further in 2009.

Key findings in the report were:

  • *Actual defaults were low in 2008 but will increase in 2009: Despite the market turmoil and contraction in credit in 2008, loan delinquencies or loans suffering payment breach and loans experiencing non-monetary breach, for example, breach of loan covenants, are currently modest: 23 out of around 1,000 loans across approximately 173 transactions.
  • By the end of 2008 there were nine delinquent loans in European CMBS, representing 1.4% of the outstanding sterling-denominated senior loan balance. 14 loans had experienced a non-monetary breach, representing 5% of the outstanding sterling senior loan balance.
  • Of the 178 classes of European CMBS notes placed on CreditWatch last year, 42 were downgraded, 30 were affirmed, and 104 remain on CreditWatch as of the date of this report.
  • *Refinancing is the key risk: Around 75% of all European CMBS loans are due to refinance in the years 2011-2014. In 2009, 30 loans are due to mature across 23 transactions, representing €994m by Euro senior loan balance and £2,957m by sterling senior loan balance.
  • *The rapid correction in UK commercial property values has not fully run its course: Values fell by 27.1% by the end of 2008, with a 5.8% decline in December alone. By comparison, in the early 1990s, it took three years for values to fall by 25%. Values and rents will also continue to fall. S&P said that a dearth of finance, weakening economic and occupier demand, and pipeline of un-let developments 'does not bode well for the future'.
  • *Lending to the commercial real estate sector is unlikely to resume before 2010: Balance-sheet allocations to commercial real estate may have to shrink as European banks seek to deleverage. New lending to commercial real estate is unlikely to be a top priority for governments at a time when they seek to influence bank lending to corporates, small and medium sized businesses, consumers, and homeowners.
  • *Servicers have an increasingly influential role to play: More loans than ever (20 at the end of 2008) in European CMBS were transferred into special servicing and servicers and special servicers are now at the forefront of decision-making on how to maximize recoveries in a sector that is experiencing marked falls in values. This has a number of implications - special servicing fees are now being paid in several transactions and these extra costs could cause a shortfall for junior classes of notes. Servicers will also need to decide how to treat breaches of loan to value ratio covenants.

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