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Interest rate cut boosts mortgage, consumer ABS; benefits mixed for CLOs

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The Federal Reserve’s interest rate cut on Wednesday will benefit mortgage- and consumer-asset-backed securities, but will bring mixed results for collateralized loan obligations, according to a report by Moody’s Investors Service.

Moody’s said the Fed’s decision to drop its benchmark lending rate to 2% from 2.25% – the first in a decade by the central bank – will boost real estate and consumer ABS collateral by helping lenders uphold underwriting standards and provide affordable debt options to borrowers.

The cuts will also boost origination demand, which should lessen revenue pressure on private lenders in the auto and personal loan space, Moody’s reported.

“When rates rise, the affordability of new debt falls, reducing consumer demand and spurring lender competition for originations, other economic conditions being equal,” the report stated. “Conversely, the recent drop in rates will support origination volume, reducing the drive to win business by lowering underwriting standards.”

For mortgages, the lower rates will uphold refinancing demand and also increase the levels of prepayments on mortgages that upon being paid down from refi proceeds will no longer be subject to default or delinquency risk.

Lower interest rates also favor commercial mortgage securitizations by providing higher debt-service coverage ratios that make borrowing more affordable, which improve credit metrics on new-issue CMBS deals. DSCR ratios have fallen since mid-2017, Moody’s reported, although they remain higher than pre-crisis levels.

For CLOs, one of the costs of lower interest rates is the dip in income stream, as the corporate floating-rate loan payments into the pools decline. That reduces the excess spread over the liabilities paid to bondholders.

“However, inexpensive debt will help CLOs' asset performance by cutting borrowing costs, a helpful boost for any company, but particularly for the low-rated companies that issue the loans that make up CLO asset pools,” the report stated.

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Interest rates RMBS CMBS CLOs CDOs Federal Reserve
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