Despite decreasing default rates for conduit loans, U.S. commercial mortgage-backed securities (CMBS) will likely sustain increasing defaults after this year due to concentrations of interest-only loans and loans with a higher amount of debt, Fitch Ratings predicts.

CMBS loan defaults fell 15% by dollar amount in 2006 to $1.57 billion, with 253 loans defaulted, according to the ratings agency’s latest CMBS loan default study, published July 11. In 2005, defaults amounted to $1.86 billion in 317 loans. Last year’s defaulted loans brought the total balance of loans in default in the study to $13 billion.

Fitch tracks CMBS defaults across vintages, or years of origination. For its most recent report, the agency added 34 fixed-rate deals with 6,756 loans totaling $89.6 billion to its study in 2006. The study now tracks 48,647 loans amounting to almost $405 billion.

CMBS defaults, which had risen each year from 1993 until they reached a peak in 2003, have declined for the past three years. Defaults were 45% lower by balance and 44% lower by count in 2006 compared with 2003, a change Fitch attributes to improved commercial real estate market performance.

The cumulative vintage 10-year average default rate — or the average rate of default over the 10-year life of a CMBS deal — is likely to rise above the current level of 7.88% after 2007, Fitch predicts. Why? Because deals issued over the last few years contain larger concentrations of interest-only loans and loans with a high amount of debt, including subordinate debt in addition to the senior loan. Loans with a great deal of debt are more susceptible to changes in revenue, Fitch states. Defaults for hotels, in particular, rose to 30% in 2003 before falling again.

Office, retail, and hotel property defaults will increase after 2007, Fitch predicts, due in part to overly optimistic expectations of future rental rates, sales growth, and market growth.