Commercial property loans signal deepening stress

By Al Yoon

NEW YORK (Reuters) - The number of stressed commercial property loans increased at an accelerated pace in December, challenging a major segment of the U.S. bond market that has shown recent signs of stability.

The percentage of commercial mortgages placed with companies that specialize in servicing troubled loans jumped 0.32 percentage point to 1.61 percent, the highest in about four years, according to JPMorgan Chase & Co.

Erosion in fundamentals of commercial property has been long forecast as the slowing economy reduces demand for office space and cuts revenues from hotels and retail shops. Investors in 2008 fled commercial mortgage-backed securities (CMBS) as signs of recession led to increased aversion from risky assets, even as overall delinquencies fell far short of those in U.S. residential real estate.

Many analysts claim the increase in CMBS risk premiums has been excessive, even under catastrophic loss estimates, having been fueled by funds seeking cash or reducing borrowings as the financial crisis deepened. But a rally in the $700 billion CMBS market in December is sputtering this week amid further erosion in market fundamentals and fresh signs of investor selling.

"Sellers may have sensed a good exit point after the December (price improvement), but the CMBS fundamentals remain weak and are unquestionably worsening," said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union in New York.

So-called special servicers are grappling with a credit market reluctant to renew financing on billions of dollars in loans, even those backed by relatively strong properties. Borrowers with loans at or near maturity, including mall-owner General Growth Properties GGP.N, are being forced to seek extensions from creditors or sell assets to avert bankruptcy.

Loans on retail and office properties appear to be leading those on servicer "watch lists," or that have been transferred to special servicers, said Erin Stafford, an analyst at bond rater DBRS in Chicago. Multifamily property delinquencies are high, but may reveal more "borrower issues" than a fundamental problems with the properties, she said.

Possible solutions for a delinquent loan on The Mix at Southbridge -- a 20,000 square foot Scottsdale, Arizona, retail center -- included modifying the mortgage, offering deed in lieu of foreclosure or an asset sale as the borrower tries to win leases, according to a DBRS report on the 2007 Bear Stearns-issued CMBS that contains the loan.