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.

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.

Many of the loans that have come through my office are of the portfolio variety.  Most are in default and the others are on the verge.  As these loans increasingly begin to default, these smaller banks will come under increasing pressure and many more will begin to fail.  Some of these banks have begun to open up to idea of modifying loans in order to cure or prevent defaults, but others are not as eager as a result of accounting rules that complicate the process.  Without a change in these accounting rules and/or government programs encouraging commercial loan modifications, a second wave of bank failures will occur and further dry up what is left of the credit markets.

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.

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.