Moody’s Investors Service said that the CMBS conduit transactions that it expects to rate in 3Q12 suggest that the average Moody’s Loan- to-Value (MLTV) ratio, which is the rating agency’s main measure of balloon refinance risk, will increase to 102.1% from 97.8% in the third quarter. Given this expected 4.3% jump, the MLTV in the third quarter will average above 100% for the first time in CMBS 2.0.
According to statistics through 1Q12, MLTV has remained stable, specifically in the mid-90s range, for five consecutive quarters. After this long period of stability, 2Q12 underwent a slight rise in leverage, which now is expected to be followed by a greater increase in 3Q12.
As conduit leverage increases, Moody’s credit enhancement (CE) levels are also bound to rise because any additional leverage will consequently impact the probability of default and the loss given default. Analysts cited early CMBS 2.0 deals that had CE for tranches rated ‘Baa3’ of about 5.8%, although they predicted that this level will increase to roughly 7.3% in the third quarter.
Moody’s tested their projection by assuming that leverage would return to its peak 2007 levels. The results reveal that the CE levels would continue to increase in this case and that the ‘Baa3’ CE would then average in the low to mid-teens, which is enough to provide a “cushion” above the losses that is expected to occur from the 2007 vintage.
Analysts said that classes at the lower end of the investment grade spectrum are particularly prone to an increase in leverage. They also expect increased subordination, specifically for the lower-end of the investment grade range of classes mentioned above. Moody’s calculated that the ‘Baa3’ enhancement will average 7.25% for third quarter deals, which is up from an average of 6% from last year.
