The percentage of interest-only loans in commercial mortgage-backed securities is rising, increasing the risk of losses in these deals.
The latest CMBS to hit the market, a $1.49 billion conduit sponsored by German American Capital Corp. and Cantor Commercial Real Estate, has weighted average Interest Only (IO) Index of 33%, according to a presale report published today by Kroll Bond Rating Agency. By comparison, the IO index on the last six CMBS deals Kroll has rated ranged between 12% and 39% and averaged 26%.
KBRA calculates an IO index for each loan, which is the number of IO payments divided by the loan term.
Paying only interest and no principal for long periods of time results in higher leverage during the loan’s term and in the event of a default, IO loans are also subject to a greater loss than a loan that has been amortizing. That's particularly true in the earlier years of the loan’s life, explained KBRA.
Kroll isn't the only ratings agency sounding the alarm. In a report published today, Standard & Poor’s also pointed to a rise in the percentage of full-term IOs in recent CMBS, saying it is a "moderate negative" for these deals. S&P calculated that the percentage of full-term IOs rose to 21% for the first 6 deals of 2013, up from 12% on all for the deals issued in 2012.
Of the nine interest only loans backing this latest CMBS conduit, which is called COMM 2013-CCRE6; four are full-term IO loans accounting for 27.5% of the transaction pool. Included in this mix is the largest loan in the deal pool secured by Federal Center Plaza (8.7%), a 725,317 million square foot office building located in Washington, D.C. Five loans have partial IO periods, ranging from 12 to 60 months. The majority of the pool however is comprised of loans with no interest-only periods.
Kroll, DBRS and Moody’s Investors Service assigned preliminary ratings of ‘AAA’/ ‘AAA’/ ‘Aaa’ respectively to the class A notes issued under the capital structure; the class B notes are rated ‘AA’/ ‘AA’/ ‘Aa3’ respectively; class C notes are rated ‘A’ / ‘A’/ ‘A3’ respectively; and the class D notes are rated ‘BBB’/ ‘BBB-‘/ ‘Baa3’ respectively. Cantor Fitzgerald and Deutsche Bank are lead managers on the deal.