The credit quality of U.S. commercial mortgages being packaged into bonds slipped further in the third quarter as borrowers piled on more debt, according to Moody's Investors Service.
The size of loans relative to property values, a ratio known at loan-to-value, or LTV, climbed to 112.2% from 108.3% in the prior three-month period, Moody's said in a statement today. Higher leverage makes it harder for landlords to pay off mortgages on the properties, which include shopping malls, hotels and office buildings.
"Loan originators continue to loosen underwriting standards, contributing to one of the largest quarter-over-quarter increases in leverage," said Moody's analyst Tad Philipp, according to the statement. "The use of aggressive and pro forma underwriting, which presents a property's net operating income as higher than sustainable levels, is on the rise."
Rating companies factor in the possibility of a decline in property values when calculating leverage on new deals.
Concern is mounting that lenders making commercial real estate loans to be bundled into securities are lowering their standards as issuance of the debt rises.
Sales are booming after the market shut down during the financial crisis in 2008, following a record $232 billion of issuance in 2007. Wall Street banks are on pace to arrange $95 billion of bonds linked to everything from strip malls to Hawaiian resorts this year, according to Jefferies LLC analysts led by Lisa Pendergast. Issuance doubled in 2013 to $80 billion, according to data compiled by Bloomberg.
Leverage levels on today's deals increasingly resemble those on transactions sold in early 2007, according to Moody's.
During the crisis and its aftermath, defaults surged after real estate values plunged as much as 42% from their 2007 peak, as measured by the Moody’s/RCA Commercial Property Price Index. The market’s collapse was fueled in part by borrowers who piled on debt based on unrealistic projections about rents and occupancies.
The delinquency rate has been falling after climbing to a record 11.2% in July 2012, according to Morgan Stanley.
