Kroll Bond Ratings Agency said in a report Monday to expect more of the aggressive growth the market of commercial mortgage backed securities (CMBS) has seen since the liquidity crisis.
But the slippage in credit standards that crept into 2013 vintage deals is also here to stay.
KBRA said to expect some more of the aggressive growth the market has seen since the liquidity crisis. The ratings agency said that since 2008-2009, the market has seen volumes increase by 30% year-over-year.
But a rising interest rate environment could lead to credit degradation if lenders and borrowers are unwilling to accept loans with lower leverage points to offset the impact of rising debt service caused by higher coupon loans.
Rising rates and declining coverage may ultimately contribute to higher defaults and losses.
The Federal Reserve announcement in May that it would look to end quantitative easing this year sent the 10-year U.S. Treasury yield to levels “not seen since 2011.” According to figures reported by KBRA the 10-year Treasury yield averaged 1.93% prior the announcement and 2.60% afterward.
A rise in Treasury yield pushed CMBS spreads wider by roughly 70 basis points to 100 plus basis points compared to prevailing mortgage rates for generic fixed rate loans, to the high 4% to low 5% range.
As of August 16, 2013, the 10-year swap rate was 2.995% versus the 10-year U.S. Treasury rate of 2.84%, according to figured published in the KBRA report.
“Balance sheet lenders and life insurance companies originate commercial real estate loans benchmarked to the 10-year U.S. Treasury yield, providing an approximately 16bps advantage over CMBS,” explained analysts at KBRA.
The disadvantage in rates could decrease conduit originations, but a decline in production is likely to be short-lived given “the high volume of maturing loans in the coming years, absent an unanticipated market dislocation,” according to the report.
The real concern, according to KBRA, is that credit quality may be negatively affected by the increased competition. “To the extent that lenders do not reduce leverage levels to compensate for increased debt service burdens, debt service coverage will decline,” said analysts in the report.