What is Delinquency Rate, and What Does it Mean for Commercial Loan Lenders?

David Cohn
Feb 17, 2023
Commercial Real Estate Lending

Over the years, the Federal Reserve's delinquency rate—the percentage of loans that have not been paid back to banks on time—has consistently fluctuated.

When the economy is booming, delinquency rates tend to fall; conversely, when economic contraction occurs, delinquencies begin to rise.

As delinquency rates continue to climb, commercial real estate (CRE) investors are likely becoming increasingly concerned about the economic repercussions of this trend.

Here's the good news: The bigger picture shows that delinquency rates—even though they are rising—remain below historical averages and haven’t skyrocketed for any particular type of credit product.

Of all loan types, commercial property loans also continue to have the lowest delinquency rates.

How delinquency rates are tracked

Generally, lenders won't flag a loan as ‘delinquent’ until the borrower overlooks two installment payments.

Following this, the lender can notify the credit reporting agencies that the borrower is 60 days overdue on payment. The lender may continue reporting late payments to credit agencies for up to 270 days if the borrower continues to stay delinquent.

After 270 days of delinquency, any federal loan is deemed to be 'in default,' according to the code of federal regulations.In the case of loans between borrowers and private lenders, individual state laws and regulations define when they enter default status. To recoup delinquent payments, lenders typically work with external collection agents.

How delinquency rates are reported

Credit bureaus can assign delinquency rate marks on the individual trade lines featured in borrowers' credit reports.

For example, if a borrower continually needs to catch up on payments, they will receive marks for being 60 days late, followed by 90, and so forth. Once a borrower makes a payment and defaults again, the tradeline will reflect this new delinquency cycle.

Credit agencies and lenders take into account all preceding errant marks when assessing an individual's creditworthiness for approval.

To ensure investors know the risks associated with certain loans, lenders usually share total delinquency rates (especially on corporate debt) based on a borrower's credit quality. This lets investors quickly gain insight into each loan's potential for success or failure.

How delinquency rates are calculated

To compute the delinquency rate, divide the delinquent loans by the total amount of loans a lender or institution owns.

For example, let's say that the lender has 1,000 loans in their loan portfolio and that 100 have missed payments of 60 or more days. You divide 100 by 1000 to get 10%, meaning the delinquency rate is 10%.

Loan types with the highest delinquency rates

According to the Federal Reserve, residential mortgage loans have the highest delinquency rates, followed by consumer credit cards, miscellaneous consumer loans, farmland loans, agricultural financing, consumer and industrial lending, and consumer leases. Commercial property loans come in last.

Of the multiple types of loans tracked by the Federal Reserve, residential real estate has been recorded as having the highest delinquency rate, while commercial real estate has the lowest.

Expected delinquency rates in 2023

As a potential recession looms closer, US credit card and personal loan delinquencies appear set to hit their highest levels in over 12 years.

As a result, lenders have already begun cutting back on originations in anticipation of the rise for 2023.

Commercial property loans appear unscathed, however according to credit-reporting firm TransUnion, serious card delinquencies are anticipated to rise from 2.1% at the close of 2022 to 2.6% by the end of next year.

In addition, unsecured personal loan delinquency rates are also predicted to increase from 4.1% to 4.3%.The same report says that credit-card originations are predicted to decrease by 7.6% in the coming year, though still higher than last year’s figures.

This dip follows two successful years of loan growth. The cause? Consumers began to rely more heavily on credit cards as pandemic restrictions relaxed and spending resumed.

But although delinquency rates are steadily rising, consumers remain relatively in control of their finances, according to analysts.Besides charge cards and personal loans, another sector is witnessing a decrease in loan originations: Mortgages.

To constrain inflation, the Federal Reserve has been raising interest rates, and these increases have also made their way into mortgage prices.

As a result, the rate of a fixed 30-year loan catapulted past 7% in 2022. This is the first time in 20 years that it has breached this level.

Loan originations for home purchases and refinancing existing mortgages have decreased drastically, with TransUnion forecasting that the downward trend will continue in 2023 to a predicted 4 million purchase originations—roughly half of the figure from 2021.

Analysts also expect to refinance originations to hit an all-time low this year of just over 1 million, a figure not seen in the last 18 years.

Delinquency rates in commercial real estate loans

Two reports, one from Trepp and one from the Mortgage Bankers Association (MBA), show that commercial mortgage delinquency rates are still generally low. However, there is a notable trend of increasing delinquencies for specific loan types.

The MBA report examined commercial property lending done by Fannie Mae and Freddie Mac as individual entities while also looking into the CMBS (commercial mortgage-backed securities) issuers, life insurance companies, banks, and thrifts to gauge their performance in this market.

These lenders hold over 80% of all outstanding commercial and multifamily mortgage debt.

When the pandemic-related shutdowns began to be imposed in 2Q 2020, delinquency rates dramatically rose for most lenders, with Freddie Mac being the lone exception (as its delinquencies were already increasing before the pandemic).

Notably, Freddie Mac had the lowest starting rate in 2018, averaging only 0.013 percent per quarter.

As a result, Fannie Mae and Freddie Mac loans dominate multifamily lending and will likely take the longest to return to their pre-COVID delinquency rates.

Life insurers—which provide around 10% of mortgages on multifamily dwellings—also saw a significant rise in delinquency rates.

In the third quarter of 2022, delinquency rates in this sector more than doubled from an already low starting point.

In the third quarter of 2022, CBMS reported a delinquency rate of 2.77 percent, life insurance companies said 0.09 percent, Fannie Mae reported 0.26%, Freddie Mac 0.13%, and banks and thrifts had an impressive rate of only 0.44%.

Meanwhile, Trepp's report digs into CMBS loans that have been overdue for at least 30 days. The analysis classifies delinquency rates by industrial property categories.

The findings illustrate that loans on multifamily property experienced an increase in delinquency rates from 0.85% in October to 1.81% in November, signaling a substantial rise of 106%.

The report says that this surge was caused by a big loan in New York becoming delinquent during the quarter. It also adds that a sizeable loan on a San Francisco multifamily property was at a high risk of delinquency.

All this said, commercial and multifamily delinquencies generally remained low by the end of the third quarter of 2022.

To illustrate, failures in bank-held CRE loan balances are currently at their second-lowest level in the past 30 years, with only the period immediately leading up to the onset of COVID being lower, according to the MBA report.

The report adds that as the conditions that created these near-record-low delinquency rates may change, it's prudent to expect that some of these loans will begin to experience more stress. Minor increases in delinquency rates for life company and Freddie Mac loans during the third quarter could be a warning sign of this buildup.

For a comprehensive overview of data since 2000, please refer to the MBA report available here. To gain access to the complete Trepp report, click here.

Opportunities in the future

Some analysts say that rising delinquencies could indicate distressed properties entering the marketplace. For instance, some debt fund loans are underwritten initially based on a solid expectation for rent growth and, at far lower rates, might be at risk of defaulting.

This could be an excellent opportunity for investors looking to capitalize on these investments.

Given the threat of a recession and the continuing erosion of borrower liquidity, commercial mortgage loans may show some distress in 2023 and for some time to come.

As a result, lenders and borrowers need to collaborate to develop loan modification strategies that are mutually advantageous.

If you are seeking financing for your CRE project, work with a reliable CRE loan placement company like Capital Investors Direct.