Experts Think Commercial Real Estate Will Continue to Perform Well.

Commercial mortgage loans have weathered the current economic downturn well and indications are that they will continue to hold up in the future. Standard & Poor's for one believes that the strong credit performance of commercial mortgage-backed securities is likely to continue into the future, based on a study of 28,593 United States commercial mortgage loans that went into S&P-rated CMBS. The loans were originated primarily between 1993 and 2000, with a total original principal balance of $234 billion and an average interest rate on the underlying mortgages of 7.87%, with two-thirds of the loans carrying a mortgage rate between 7% and 9%.

Joseph Hu, a managing director in S&P's structured finance group, said, "With the real estate market gradually gaining strength following the anticipated stronger economic recovery in the second half of 2003 and beyond, one can expect that CMBS will continue to perform strongly."

For the purposes of the study, conducted by Dr. Hu and Roy Chun, another S&P credit analyst, a loan is considered to have defaulted if it became 60-days delinquent. As of March 31, 2003, 1,006 of the loans studied had defaulted. The S&P researchers have also used the findings from the study to come up with a default model to estimate the probability of default of commercial mortgages. Loans originated in 1995 had the worst credit performance of all the vintages, the study finds, with an annual default rate that escalated from 0.44% in the second year to a high of 2.37% in the eighth year. The 1995 loans had a nine-year cumulative default rate of 7.64%, which was the highest of all.

The theory that the credit performance of commercial mortgages depends more on the vitality of the local economy than the national one is borne out by the study. California and New York, two states that experienced great prosperity during the 1990s, had "markedly low cumulative default rates" of 1.1% and 2.5%, respectively.

On the other hand, Ohio and Florida, two states that did not share in the prosperity and property value appreciation of the 1990s, had "rather high cumulative default rates" of 5.2% and 4.8%, respectively. However, the incidence of default overall is linked to conditions in the national economy. During periods of economic prosperity there is a scant likelihood that commercial mortgage loans will default, while they are more likely to default at higher ...