Once a CMBS loan goes into default, it is generally moved to what is a called a special servicer.  Often times, this is simply another division of the master servicer.  The special servicer has the authority to make modifications to the original loan in order to maximize the return to the investor.  This gives the special servicer a broad range of duties and powers, but is also very labor intensive.  The influx of defaults and the subsequent strain on its special servicing unit was a critical factor leading to Capmark’s bankruptcy.

The government must act in a manner that allows these banks to rework these loans to reflect the current market.  Another wave of foreclosures is not the answer.  Although many economists may say that foreclosures are needed in order to bring the market back into equilibrium, that theory may be too drastic when our economy is in such turmoil.  A better solution may be to set forth guidelines that will allow these loans to be worked out and give the overall economy time to recover.  A commercial loan modification will also be less costly for banks than going through the foreclosure process while providing them the opportunity to recoup their entire debt.

A set of guidelines by the FDIC is what the market needs in order avert the disaster that befell the residential real estate market.  Encouraging lenders to modify these commercial mortgages will serve to stabilize the market by preventing a flood of foreclosures from coming online over the next three years.  These guidelines could provide for loan extensions at lower interest rates which will serve to address the issue of the influx of loan maturities that are expected.  Since the available funds for refinancing are minimal at best, such programs are necessary to maintain some sense of stability in the market until the economy can turn around.

With commercial mortgage defaults mounting and the lack of a clear plan on the part of the banks and the government as to how to deal with this issue, 2012 may be the point where we get to see just how bad the damage is.  The common theme that I’ve been seeing is that banks are at times hesitant to modify loans because of FDIC regulations that make accounting for these modifications very difficult on the bank’s books.  Although there is some benefit for the bank in foreclosure and ridding themselves of these assets, it seems that a greater benefit for the economy as a whole would be to modify these loans to reflect the current market and stabilize the market using that route.

Chances for a recovery in the commercial market seem slim in the short run as the combination of falling rents, falling property values, an increasing number of maturing loans and a lack of liquidity in the credit markets all work together to drag prices down.  Industrial properties seem to have taken the biggest hit as industrial production is most directly impacted by the recession. 

From what I have been seeing, almost all defaults are a result of missed payments.  This can be a result of owner-users losing business revenue or third party investors receiving reduced rents either as a result of not being able to rent out vacancies or tenants vacating as a result of the economy.  With defaults expected to be at &5 at the end of this years, it appears that the worst is yet to come between 2010-2012 when many commercial loans begin to mature.

Maguire briefly mentions that restructuring the debt is an option but it appears that their situation may be too dire.  Analysts believe that their entire portfolio may be under water, making a long term restructuring solution a very unlikely option.  Nevertheless, a restructuring option is still on the table and for individual investors may be more realistic than for an institutional investor like Maguire.  The workout of a small single asset debt is much less of a daunting task than restructuring over a billion dollars worth of CMBS debt.

This is fairly significant news in that pension funds are major players in the real estate market and getting them back into the game will be a major boost for commercial real estate.  Also noteworthy is the fact that they invested in retail properties which is an asset class that has been and will continue to be hit very hard by the current recession.  This purchase, along with a $463 million investment made by California Public Employees’ Retirement System in a portfolio of 86 shopping centers, is a very positive indication.  These could very well be anomalies, but with the market the way it currently is any sign of hope is good.  I’m going to keep monitoring these developments and keep you posted of any new positive signs.

Interestingly enough, the worsening problems on the commercial side seem to have more to do with the fledgling economy that has reduced rents and caused many business to break leases and less to do with the lack of liquidity that most analysts believed would be the root of the problem.  As a result, defaults are occurring sooner than expected because the defaults are now a result of inability of borrowers to make mortgage payments and not the inability of borrowers to refinance upon maturity which was the original concern.

Regardless, lenders are going to have to start addressing the commercial real estate market and are going to have to do it soon.  It will be interesting to see if they learn from the residential meltdown or if they will make the same mistakes before they begin further embracing the loan modification concept that salvaged what was left of the residential market.  Many banks have already seen the light, now it’s time for the rest to follow suit.