The Journal and Bloomberg report today that two big commercial real estate loans are about to default and yesterday the commercial mortgage-backed securities market cratered as a result. It looks like the next shoe may be dropping.

What’s got investors extra spooked is that these loans have soured so quickly, a sign that others in their “vintage”—the same year they were made—may go bad more quickly too. Troubles with specific loans in a vintage often signal trouble for others in the same year since lending standards tend to have been similar.

The Journal’s headline is misleading, though, saying “CMBS Market Begins to Show Fissures”. I, for one, wrote about that happening going on two years ago.

The WSJ has valuable information that Bloomberg does not:

The Westin loan, which J.P. Morgan made in December, projected a $23.7 million annual cash flow for the property, 13% higher than what it was at the time. The loan represented about 70% of the purchase price of the property. An official at the borrower, Transwest in Tucson, declined to comment.

When the Promenade loan was made in July 2007, the property’s cash flow was $6.3 million, but J.P. Morgan underwrote it on the assumption it would rise to about $10.5 million. About $8.8 million in reserves were set up when the loan was made. The reserves, intended to cover certain expenses, are down to about $2.8 million today.

That means the loans were underwritten with fantasy cashflows. JPMorgan was assuming the landlords could quickly raise rents or increase occupancies significantly, which apparently didn’t happen.

It’s important to realize that though there was insane lending in commercial real estate, it was somewhat more restrained than that in housing—plus malls and hotels have rental income that pays off loans even when property values decline (all bets are off when they’re underwritten like the ones here, though). Bloomberg provides the context here, though comparing subprime housing bonds to all commercial real estate bonds is a bit apples to oranges:

Delinquencies on commercial real estate debt rose to 0.78 percent in October, from 0.66 percent in September, according to RBS Greenwich data. About 35 percent of all subprime mortgages backing bonds are least 30 days late, according to data complied by Bloomberg.

A better comparison might have been the delinquency rate of all mortgage-backed securities, but it’s stunning to see that 35 percent number on subprime.

Still, there are going to be a lot of hotels and malls and office buildings going under. How many will depend on how bad the economy really gets.

 

 

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu.