According the Mortgage Bankers Association’s 3^rd quarter report, the “Commercial/Multi-family Delinquency Rates for Major Investor Groups”, commercial loans underwritten by commercial mortgage backed securities (CMBS) have seen an increase in delinquency rates to a new high of 4.06 percent.  The delinquency rate for CMBS is now the now at the highest level ever recorded.  This presents a serious problem for many commercial property owners who have loans that were packaged as CMBS because the commercial loan modification process for these loans can be a cumbersome and difficult process that is further complicated by the fact that there are many levels of ownership that must be considered during the commercial loan modification process.

CMBS are designed to build in a certain level of defaults.  The problem the industry is facing now is that defaults have increased well beyond what had originally been projected. Now the bond holders of the securities are facing the prospect of losing their investment capital.  CMBS loans are structured with different levels of bond holders.  Those at the top of the ownership chain, generally banks, will recover the most money in the case of a foreclosure.  Those at the top are referred to as senior bond holders.  The bondholders who took on more risk, expecting a greater return, are known as the junior bondholders.  The rights of bondholders are protected by agreements such as the Pooling and Service Agreement (PSA) which provides voting rights to junior bondholders.  The differing interests between senior and junior bondholders can make a commercial loan modification a difficult and lengthy process.

For example, an apartment building might have an outstanding loan balance of $20 million, but the actual value has dropped to $15 million.  The borrower might agree to support the debt at the current value of $15 million if the $5 million is written off.  If you make this proposal to the senior bond holders they will probably agree but the junior bondholders, at the bottom, will probably end up eating most of that write off and will not be willing to take the loss.  In fact, if the junior bondholders are dealing with three or four of these discounts at the same time, they could get totally wiped out and realize a 100% loss on their investment capital.

For this reason, those investors who stand in the first loss position are very adverse to approving a write-off.  Different lenders and bondholders on different rungs of the ladder have different interests.  It can be difficult to work out a successful commercial loan modification.

There is a potential tidal wave building right now in the commercial real estate market with $1.7 trillion of outstanding CRE debt on bank books.  Currently, most commercial loan defaults are occurring as the note balloons. Commercial property values have dropped by 40% in most areas of the country and with stricter underwriting guidelines most commercial real estate owners are finding it impossible to refinance their loans.