NYC commercial loan default likely, more seen-Lehman

NEW YORK, Aug 18 (Reuters) - An imminent default of a $225 million New York City apartment complex loan represents only the first commercial real estate mortgage featuring an aggressive type of underwriting that likely will go bad, Lehman Brothers said in a report.

The loan, for the Riverton Apartments high-rise in Harlem, was made assuming that the borrower would be able to convert 53 percent of rent-stabilized units to market prices two to three times higher by 2011, boosting cash flows, Lehman analysts said in the report dated Monday.

But the pace of conversion has been slow, leaving the current debt service coverage ratio at 0.28 times, versus the 1.73 times under the assumed boost in rents.

The so-called "pro forma" underwritings accepted by investors in 2006 and 2007 are present in at least $5.4 billion of loans in commercial mortgage-backed securities, including more than $1 billion for the 2006 purchase of Peter Cooper Village and Stuyvesant Town apartment complex in New York.

Investors have shunned CMBS along with other credit-related securities this year amid concern that the slowing economy would exacerbate a rise in defaults from historically low levels. As in residential real estate, dealers seeking to ramp up issuance in 2006 and 2007 loosened requirements for loans that could be packaged into bonds, often accepting larger loan sizes relative to the value of the property.

"We expect that additional pro forma loans will likely suffer a fate similar to Riverton Apartments," Lehman analysts wrote in the note confirmed by analyst Aaron Bryson.

"In addition to aggressive upside assumptions, weakening commercial real estate fundamentals will likely put further pressure on the borrower, increasing the value of the borrowers' 'default option' to walk away from a property with non-recourse, in our view," the analysts added.

Lehman noted that assumptions for increased cash flows for loans in CMBS vary widely.

Riverton Apartments loan sponsors Rockpoint Group LLC and Stellar Management "appear ready to exercise" their default option, Lehman said in the report. The loan, contributed to a CMBS issue by Deutsche Bank AG, will probably sustain a loss of 50 percent, it estimated.

Downgrades from major credit rating companies should be forthcoming, it said. (Reporting by Al Yoon; Editing by Dan Grebler)