Commercial mortgage underwriting standards have already loosened dramatically this year, but it seems that some borrowers are still trying to get away with a little more.
Fitch Ratings warned Friday that it has been “surprised” to see an increasing number of requests by borrowers to change the terms of loans backing mortgage bonds shortly after securitization. Some of the proposed changes, had they been known by Fitch prior to issuance, would have meant the loan being modeled differently, and often, more conservatively.
When changes are made to CMBS loans, particularly some of the larger loans in a pool, the deal’s servicer may ask Fitch to confirm its ratings on a deal, though Fitch said is under no obligation to do so, and can subsequently downgrade deals or individual tranches of deals.
The rating agency has seen approximately 15 requests this year for rating confirmations pertaining to loans from 2014 or 2015 vintage deals. It said the majority of the requests have been loan assumptions to new borrowing entities or ownership structures. However, a handful have contemplated more fundamental changes to other loan terms.
“One such request, and one of particular concern to Fitch, is the borrower trying to add more debt,” the report states. Additional debt, particularly in the form of preferred equity or mezzanine debt, would cause the rating agency to assign a higher probability of default and resulting higher expected loss in its modeling of the loan. Unless the loan and/or the transaction had experienced increased cash flow and amortization, Fitch would be unlikely to say that a downgrade would not be warranted.
Fitch said the majority of confirmation requests it has received from servicers this year, 75, have been to defease loans, or replace the loan with enough cash or securities sufficient to service the mortgage bonds. These defeasance requests came mainly from legacy transactions originated in peak vintage years. Approximately 20 of these requests were from 2.0 transactions, in particular from the 2011 through 2013 vintages. Borrowers are locked out from defeasing loans within the first two years of origination, but there appears to be no such lockout for other changes to the loan, providing the lender gives consent.
Fitch said it will continue to factor in any additional risk profile when considering requests for no downgrade confirmations and “will not hesitate to refuse to issue one it views the change as increasing the credit risk of the bonds in question.” This is more likely if the loan is a large one and the request is within several years of the transaction closing.