The 2000 vintage CMBS was an anomaly with higher-than-expected delinquencies but its lackluster performance shows that the real estate cycle still matters, concluded Moody's Investors Service in a report released last week on CMBS loans.

Moody's produced two reports on CMBS loans looking at delinquencies in terms of their place in the real estate cycle as well as their relationship with loan level credit migration.

The rating agency is seeking to get a better handle on the drivers of delinquencies, said Sally Gordon, vice president at Moody's.

The first report analyzes the drivers of delinquency in the sector. It stated that delinquency generally follows a smooth progression by vintage, with older deals having higher delinquencies. However, the 2000 vintage, which represents the peak of the cycle, is considered an anomaly as it showed higher-than-expected delinquencies. This proves that loans underwritten at the peak of the real estate market are, in effect, higher risk. The report noted that in this instance, the hotel sector is not the sole reason for the underperformance but all major property types were responsible.

"The vintage end makes a very compelling case that, while real estate is now part of the capital markets, the old-fashioned property market dynamics still matter," said Gordon.

The underperformance of the 2000 vintage is proof that the real estate cycle still counts. This year saw the lowest vacancy rates and the highest rents for all major property types, with loans underwritten in 2000 often facing comparatively harder market environments if owner/borrowers had to replace tenants.

This means that, for instance, finding a new tenant for any property that was underwritten in the year 2000 would be harder because this would inevitably have to be done in a softer market. The net effect is that overall cash flow on the property is more likely to be less than anticipated. In a weaker part of the real estate cycle, as it gets more difficult to attract tenants, owners might have to lower rents, leading to less income. And this shortfall in income could result in owners missing mortgage payments, which might ultimately lead to loan defaults.

It should be noted that Moody's use of sustainable cash flows in studying the underlying collateral lessens the impact of the credit cycle.

Meanwhile, in the second report, the rating agency looked at the link between loan level credit migration and delinquency. Most notable is the report showing a lower-than-expected percentage of loans in the 90-plus day past due category went into foreclosure.

About 30% of loans that were 90-plus days past due slipped into foreclosure/real estate owned (REO) in a year. This is less compared to the occurrence of repeat offenders. Roughly 40% of loans that were 90-plus days past due a year ago cured, totally or in part, then returned to that phase of stress.

However, the fewer-than-expected number of foreclosures should not necessarily be seen as a good sign. The rating agency said that results from the last year might not be replicated in the immediate future for many reasons, such as a reversal of direction in interest rates and weaker property markets.

For instance, in a falling real estate environment, borrowers are able to secure lower interest rates so their debt service payment is reduced. This means that they have to spend less of the cash flow on the property to make their mortgage payment. However, the benefit disappears in a rising rate environment.

Moody's also found that delinquent loans manifest considerable movement between different phases of delinquency, moving from being 30 days past due to either being 60- or 90-plus past due, and finally into foreclosure or REO. However, the report said a loan that is 90-plus days past due would not necessarily deteriorate further as the trend cited above shows.

Both studies were based on 42,888 CMBS loans, totaling $284.7 billion.

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