Fitch: Poor Economy Eclipses War's Impact on CMBS Transactions.

Business Editors

Topical News: War On Terrorism 

NEW YORK--(BUSINESS WIRE)--March 25, 2003

The war in Iraq is not the catalyst for the weak fundamentals Fitch Ratings is currently observing in the commercial real estate markets.

'The implications of the war in Iraq may be to exacerbate weak economic conditions in different geographic areas and among various property types,' said Susan Merrick, Managing Director, Fitch Ratings. 'Fitch expects the current economic pressures to result in increased defaults and losses in non-investment grade CMBS bonds. Given the sound structural protections in CMBS transactions, investment grade bonds can weather the current economic instability.'

Over the past few weeks, general uncertainty about if and when the United States would go to war has absorbed most people's attention. Since the first bomb dropped in Iraq, many people have been glued to their televisions, anxious for news and analysis of the war and its effects. Now that the country is at war, many are focused on its expected length and economic impact.

To date, the economy has stalled. The uncertainty has itself been a source of weakness. Consumer confidence and spending are down. Capital investment in industry has been virtually absent. Manufacturing and durable goods orders are up nominally. Job losses continue to increase. However, given the size and diversity of the majority of commercial mortgage-backed securities (CMBS) transactions, Fitch expects that investment grade classes will be well insulated from downgrades. Overall, while delinquencies in Fitch-rated CMBS transactions remain low to date, Fitch expects they will likely increase in the next twelve months as declining real estate fundamentals continue in numerous markets and property types.

The war will have some clear consequences: fewer people will travel, and the airline and tourism industries will suffer. Already, in the first two months of 2003, Fitch has seen hotel delinquencies in CMBS transactions spike. Fitch expects hotel loan delinquencies and defaults to increase, especially if the war is prolonged and threats of terrorism in the U.S. remain high. Certain geographic areas which are especially dependent on tourism will be most affected. Fitch witnessed a slow rebound after Sept. 11, 2001 which did not materialize until six to nine months after the attack. Another event would take at least that long to rebound since the economy is less stable today.

Year over year retail sales are down, partly due to adverse winter weather conditions in many areas of the country. A short war may slow down retail sales in the near term. It could force some already tenuous retailers into bankruptcy. A question remains as to whether, in a prolonged war, consumers will consider shopping a welcome diversion or a frivolity to be postponed until a more stable period. Retail loans comprise 29% of the year end 2002 Fitch Delinquency Index, a number which has declined by more than 10% during 2002. Fitch does not expect substantial increases in delinquencies on mortgage loans backed by retail properties, despite predictions of lower sales, unless there are additional bankruptcies among major retailers.

Low interest rates will prop up some weak real estate loans but further deteriorations in cash flow resulting from continued corporate retrenchment could create a rise in office delinquencies. In the most recent quarter, office loan delinquencies increased by 45% from $138 million to $200 million, a consequence of tenants relinquishing office space and landlords having difficulty in just finding tenants, not just replacing those higher rents. To date, increased employee productivity has mitigated reduced corporate earnings. Job creation, capital investment and increased demand need to occur before the office markets stabilize.

Low interest rates, and the ability to finance a greater amount of the purchase price, have encouraged many renters in multifamily projects to purchase single-family homes. Multifamily vacancies in many turbulent economic markets including Austin, Denver, Las Vegas and San Francisco have been exacerbated by job contraction while other markets, Atlanta for example, have been overbuilt. With increased concessions, Fitch is seeing the usually stable multifamily properties experiencing stress in some transactions. Again, given the size and diversity of most CMBS pools, it will not have an overwhelmingly negative effect on transactions.

Another unknown looming over the CMBS market is the possibility of terrorist attacks. One month has passed since the deadline imposed by the Terrorism Risk Insurance Act (TRIA) legislation requiring property and casualty insurers to provide property owners quotes on terrorism insurance. The market for terrorism insurance is slowly restarting. However, another terrorist attack in the United States could rekindle the event risk which widened spreads on single asset CMBS deals post Sept. 11. With the increase in the number of fusion transactions, a larger portion of the CMBS market could be affected.