Fitch in fresh mortgage warning

By Saskia Scholtes in New York Tue Apr 3, 1:55 PM ET

This year's crop of commercial property mortgages could face sharply higher defaults than in previous years amid pervasive loose lending practices and overconfidence in the sector, according to Fitch Ratings.

The warning echoes the turmoil in the risky US subprime home loan market, where lax underwriting and a sharp slowdown in the housing market have resulted in a steep increase in mortgage payment problems in recent months.

Unlike the residential market, commercial property values are still rising. But Fitch said the recent downturn in the market for subprime residential mortgages "should caution investors about the dangers of mixing aggressive underwriting with reliance on continued price appreciation".

The agency said defaults on commercial mortgages originated this year could be up to 15 per cent higher than in recent years. Bonds backed by commercial property loans have become popular in recent years as investors have sought to diversify holdings and tap into rising US commercial property prices.

The phenomenon has granted borrowers easy access to capital and prompted the development of new, more highly leveraged debt structures.

Fitch said properties were also increasingly financed with no money down or even with loans for more than 100 per cent of a property's value as owners borrowed greater amounts upfront to pay interest costs, betting that cash flows would improve quickly enough for the property to be self-sustaining.

"Real estate professionals are structuring loans today with the expectation that cash flow will continue to rise in a commercial real estate market that has already experienced dramatic upward trends," said Eric Rothfeld, senior director at Fitch.

"Fitch is seeing the market financing the higher value prematurely, based on the expectation that it will occur, but well before it does or does not come to exist," he added.

For instance, the rating agency said it had seen underwriting on numerous office properties where the existing cash flows were adjusted to reflect continued long-term growth in property values and rents, even when properties were vacant or leases were not due for renewal within the life of the loan.

Fitch warned that, in some parts of the commercial mortgage market, there were signs that such aggressive lending practices were already causing problems.