Moody’s: CMBS Loan Leverage Falls for First Time Since 2013

Commercial mortgage-backed securities’ credit quality as measured by loan-to-value ratios improved during the first three months of this year, reported Moody’s Investors Service, New York. 

The Moody’s LTV ratio declined to 118.1 percent in the first quarter from 118.9 percent in late 2015, the first decrease since early 2013. Conduit loan leverage nevertheless remains slightly above the pre-crisis peak MLTV of 117.5 percent.

“The credit pendulum swung in favor of subordinate bond buyers late last year, and increasingly they are helping to ‘shape’ conduit pools,” said Moody’s Director of Commercial Real Estate Research Tad Philipp. 

Philipp noted that issuers appear to be exercising greater underwriting discipline. Underwritten LTV (as reported by issuers) dropped to 64 percent in the first quarter from 65 percent in fourth-quarter 2015 while fewer loans were originated at or near 75 percent LTV, he said. He noted that property price appreciation has cooled in the past few months, which could further boost credit. Since most loans are sized to a percentage of market value, a lower market value could result in a smaller portion of loan proceeds being advanced against cash flow.

“There’s an interesting confluence of factors contributing to spread tightening over the past six weeks,” said Brian Olasov, Executive Director of Financial Services Consulting with Carlton Fields, New York. “Tighter underwriting may be one factor, the emergence of all bank pools and pool shaping by B-piece buyers may be others.” 

Olasov said the scarcity of new issuance–down about 40 percent year-to-date–probably overwhelms the slightly improved credit metrics. “If clearing the market today requires higher credit standards, I wonder how much of the impending refinancing wave is going to be able to roll over into new CMBS,” he said. 

Philipp said the cash flow haircuts Moody’s assesses have doubled since 2012 and now top 10 percent. Moody’s haircuts cash flow to what it considers “sustainable” levels. Meanwhile, conduit loan coupons have trended up since second-quarter 2015, but remain lower than during the late stages of CMBS 1.0. Loan coupons during 2006 and 2007, the vintages that now comprise the refinancing wave, were typically nearly 6 percent, one percentage point above current levels.

Acquisition loans accounted for 28 percent of CMBS loan originations last year, Moody’s U.S. CMBS Q1 Review said. The portion of CMBS comprised of acquisition loans tends to rise when prices near a peak and ease off when they near a trough. “A volatile CMBS market may deter borrowers from considering CMBS loans to fund acquisitions,” the report said. “Assuming the acquisition price held steady, the borrower’s return on equity would decrease to the extent that the loan coupon increased.”