Steeper Interest Rates to Increase CMBS Risk

Rising interest rates next year will heighten both the term risk of new deals and the refinance risk of outstanding commercial mortgage-backed securities, Moody’s Investors Service predicts.

Ratings should remain the same.

While increasing long-term interest rates typically goes hand-in-hand with rising rental income, there can be a delay, the agency said in a report released Monday. Higher rates nationwide can translate into higher rents but there are some exceptions. “The property market response is distinctly local and can lag in metro areas that [lack] a healthy supply/demand balance,” the agency says.

In addition, major CMBS sectors still exhibit excess inventory. This must be re-absorbed into the market before rents can rise.

Rates will have gone up by 2016, which is around the time that 10-year deals that came out during the peak years of 2006-07 will be maturing, Moody’s forecasts.

The quality of commercial mortgage-backed securities collateral has deteriorated over the last year, although it is nowhere near the level hit during the issuance boom of 2007, according to the agency. The average loan-to-value ratio will be 103% by yearend 2013, Moody’s predicts. This is up from 98% at the start of year, but well below the peak level of 118%.

Ratings of CMBS will be stable in 2014 thanks to relatively conservative underwriting and high debt-service coverage levels that have been in place since the crisis as well as to a recovering economy, according to Moody’s.

“Affirmations will constitute most of our ratings actions, with the remainder roughly evenly divided between upgrades and downgrades,” the agency says.

It forecasts a slight fall in the share of delinquent and specially serviced deals.