Competition may force CMBS issuers to pursue higher LTV loans

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Growing competition may prompt commercial mortgage-backed securities issuers to accept higher loan-to-value ratios in their deals.

"Many market participants believe that increased conduit leverage is required for the CMBS market to effectively compete for future commercial real estate loans and maintain CMBS conduit issuance at sustainable levels," Fitch Ratings analysts wrote in a report.

Although commercial mortgage leverage has been falling, the shift could put pressure on mortgage performance.

If underwriting loosens in the commercial mortgage-backed securities market and leverage rises, expected losses from loans could rise, according to Fitch's models.

A CMBS deal with multiple borrowers and an adjusted 108% loan-to-value ratio has a 4.7% expected loss rate. In comparison, 125% LTV equivalent has an 8.6% expected loss rate, according to the report by Fitch analysts Ryan Frank, Robert Vrchota, Christine Hartnett and Huxley Somerville.

But the increase may not be that substantial. A more moderate increase with a less dramatic effect on expected losses also is possible, according to the report.

If LTVs rise, it will mark a change in direction for the market. LTVs have fallen slightly in recent years due to influences such as risk retention requirements.

In addition to potentially higher LTVs, higher interest rates could put pressure on the commercial mortgage performance this year.

However, "interest rates on most commercial property types could increase to 5% (4.5% for multifamily and 6% for hotel) before modeled losses are affected," according to Fitch.

Overall, CMBS delinquencies have declined in recent months, but the decreases have been driven largely by more loosely written legacy product that has been running off.

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CMBS Underwriting Securitization Risk retention Interest rates Commercial mortgages Fitch