Moody’s didn’t grade the lower-ranking debt in 9 of the 14 commercial-mortgage bond transactions it’s rated since mid-July, according to Jefferies Group LLC. Deutsche Bank AG, Cantor Fitzgerald LP and UBS AG are selling a $1 billion transaction this week that doesn’t carry a Moody’s designation for a $64.3 million portion that Fitch Ratings and Kroll Bond Rating Agency ranked the lowest level of investment grade, said two people with knowledge of the deal.
Moody’s absence from the riskier securities in commercial-mortgage deals suggests the New York-based firm is taking a harsher view of the quality of some new loans as issuance surges in the $550 billion market, Jefferies analysts led by Lisa Pendergast said in a report last week. Credit Suisse Group AG’s forecast for $70 billion of offerings this year would be the most since issuance peaked at $232 billion in 2007.
“We have been observing a degradation in credit quality for some time” in the CMBS market, said Stuart Lippman, the chief investment officer and founder of hedge-fund firm TIG Advisors’s securitized-assets fund. “In February, we decided new issuance wasn’t priced appropriately for us to continue to participate.”
Tom Lemmon, a spokesman for Moody’s, declined to comment on the deals or on its standards, as did representatives for Fitch, Deutsche Bank, Cantor and UBS. Moody’s, which has rated 29 transactions this year, graded the rest of the deal being marketed by those firms, said the people, who asked not to be identified because terms aren’t public.
Moody’s absence from the deal portions “is a testament to the fact that the market is accepting other opinions,” Kim Diamond, the head of structured finance at Kroll, said in a telephone interview.
Commercial-mortgage bond deals can have 10 or more classes that span the rating spectrum from AAA to BB, drawing investors with differing risk appetites ranging from insurance companies to hedge funds, according to data compiled by Bloomberg. As much as 70% of the transactions are given top grades, with the bottom classes the first to absorb losses when borrowers default.
Investment-grade ratings are a prerequisite for many investors, according to Lippman, who ran securitized secondary debt trading at UBS until 2007.
“Typically insurance companies and traditional money managers are more restricted, and ratings can often determine the depth of demand,” he said. “Although some discredit the rating agencies, if their role wasn’t of value, then issuers wouldn’t pay to have them rate deals.”
Looser lending standards on new offerings are a headwind in the commercial-mortgage bond market, JPMorgan Chase & Co. analysts said in an Oct. 18 report. Underwriting has “steadily deteriorated” in 2013, according to the New York-based analysts led by Ed Reardon.
Loans that allow borrowers to defer principal payments for at least part of the term increased to an average 55% of mortgages packaged into deals this month, from 41% in the fourth quarter of 2012, according to data from Bank of America Corp. That means borrowers build less equity in the property, potentially making it more difficult to refinance.
Delinquencies on all commercial mortgages contained in bonds are falling after surging to records last year, helping fuel demand for the debt. Payments more than 30 days late declined 23 basis points to 9.93% this month, according to Morgan Stanley.
Wall Street banks have arranged $61 billion in commercial-mortgage bond offerings this year, up from about $41 billion in all of 2012, Bloomberg data show. Top-ranked securities are yielding 131 basis points more than Treasuries, down from a 2013 high of 143 basis points on July 3, according to a Bank of America Merrill Lynch index data. The debt has returned 0.7% this month.
“In certain instances there is a bit of credit creep,” Kroll’s Diamond said. “Then you will have a market dislocation of some sort like widening spreads and the loan originators will retrench a bit. As a result, the next wave of deals will have better credit characteristics than the transactions that came before.”
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.
One factor on which Moody’s takes a stricter view than other rating companies is concentration risk, meaning that if the deal isn’t diversified it will require greater credit protection even if the loans are otherwise conservative, according to a banker who structures the deals and asked not to be identified because talks with the ratings companies are private.
“Moody’s lack of participation in some more recent deals suggests that perhaps they see some of the risks we see,” said TIG’s Lippman.