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CMBS Underwriting Deteriorates

More credit enhancement will be needed in Q1

Jan. 23, 2014

By Mortgage Daily staff

Thanks to relaxed underwriting standards, risk on securitized commercial real estate loans has deteriorated to levels not seen in nine years.

Credit quality on conduit loans included in U.S. commercial mortgage-backed securities has declined to the levels of the late 2005 issuance.

As a result, CMBS transaction require more credit enhancement in order to offset increased conduit loan credit risk.

That was according to US CMBS Q4 Review: Competition Heats Up Among Conduit Lenders, Collateral Quality Continues to Slip announced Thursday by Moody's Investors Service.

The ratings agency noted that Credit enhancement levels for deals in the first quarter will be nearly 9 percent in order to achieve a Baa3 rating. That's 300 basis points more than for earlier CMBS 2.0 deals.

"The average Moody's loan-to-value ratio for conduit CMBS transactions that we rated in Q4 2013 increased 50 basis points to 103.5 percent, a CMBS 2.0 high," Moody's Director of Commercial Real Estate Research Tad Philipp said in the report. "Conduit leverage will increase more in first-quarter 2014, with a quarter of loans sized to about 75 percent of market value, traditionally the boundary of underwriters' guidelines. As conduit loan credit risk has increased, so too have our credit enhancement levels."

The report indicated that leverage has also risen due to a higher share of subordinate debt backing conduit loans. Philipp noted that one-in-eight fourth-quarter loans had subordinate debt -- requiring credit enhancement.

Moody's said that although loan leverage in first-quarter transactions aligns with second-half 2006 transactions based on LTV, overall credit quality "aligns with that of the late 2005 issuance afforded by current debt service coverage ratio levels, and the lower share of interest-only loans."

Master leases could strain credit quality even more because they make the collateral appear more fully leased and the income higher than it is in reality.

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