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Moody’s Increases CMBS Protection as Loans Become Riskier

OCT 28, 2013 5:25pm ET
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Moody’s Investors Service is boosting the level of credit protection required to achieve investment-grade rankings on newly issued commercial-mortgage bonds as loans get risker.

The so-called credit enhancement on such debt averaged 7.6% in the third quarter, up from 5.8% percent in 2011, Moody’s said today in a statement. Credit enhancement is equal to the amount of losses the deal can withstand before the security loses principal.

The ratings company is adjusting its rankings as competition between lenders increases amid surging sales. Issuance is poised to double to $70 billion this year, according to Credit Suisse Group AG. Offerings are reviving after the market froze during the credit market seizure in 2008 following a record $232 billion sold in 2007.

“Issuers continue to originate loans backed by weak malls even as first-generation loans backed by similar collateral have realized large losses,” Moody’s analyst Tad Philipp said in the statement. “This exemplifies why we need continued diligence on these transactions.”

Moody’s said last year it was altering the way it assesses weaker shopping malls contained in CMBS deals, citing a growing number of properties that may struggle to survive.

Wall Street banks that package commercial mortgages into bonds are forgoing a ranking from the rater on riskier portions of deals as Moody’s toughens its stance. The New York-based ratings business didn’t grade lower-ranking portions on nine of 14 deals it’s rated since mid-July, according to Jefferies Group Inc.

Wells Fargo & Co. and Royal Bank of Scotland Group Plc are currently marketing a $904 million commercial-mortgage bond deal that doesn’t include Moody’s on a $47.4 million portion that Fitch Ratings and DBRS Ltd. ranked the lowest rung of investment grade, according to people with knowledge of the transaction who asked not to be identified because terms aren’t public.

The size of property loans relative to buildings’ values, or the LTV, is climbing, according to Moody’s. The average LTV increased to 103% in the third quarter from 102.6% in the prior three-month period, the report said. Higher leverage makes it harder to pay off debt.

Banks have submitted mortgages with LTVs as high as 150% for review to be included in commercial mortgage-backed securities offerings, according to Moody’s. Such loans were excluded after the reviews, Moody’s said.

“The fact that they continue to be originated indicates that flaws remain within the CMBS business model,” the analysts led by Philipp said in the report.

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