Moody’s Investors Service said today that it expected European commercial mortgage-backed securities (CMBS) to suffer further interest shortfalls, at least among the non-senior tranches.
The types of deals that are most vulnerable are those that feature higher shortfalls at the loan level; mechanisms for reducing loan appraisals; and smaller loan pools on a certain interest payment date.
While Moody’s acknowledged that ultimately poor collateral performance was the main driver of interest shortfalls, other particularities of transactions can increase the chance that they will occur.
Structural provisions that limit external liquidity support — such as a bridge facility — could lead to inadequate funds for the issuer to make interest payments.
Special servicing on troubled loans can also push a deal towards interest shortfalls, as the associated fees whittle down the money available for payments. “Ultimately, junior noteholders suffer interest rate shortfalls as neither liquidity facility drawings nor excess spreads can cover these fees.”
Repayments are an issue as well, particularly when they are on the highest-yielding collateral. Plucking one of those loans from the pool eats into the overall payments.
Still, Moody’s believes that highly rated tranches in the arena of European CMBS should not experience interest-rate shortfalls. “Our ratings on these classes often address the timely payment of interest,” the agency said.
Moody’s added that market players are just starting to tackle the issue, though concrete action has yet to be taken.
“The Commercial Real Estate Finance Council Europe (CREFCE) has made suggestions for various improvements to new transactions in order to address interest shortfalls on CMBS notes, including the revenue-extraction mechanism (use of excess spreads), and the proper use of liquidity facility mechanisms, among other structural features,” Moody’s said.
Only last month, Fitch Ratings warned of shortfalls in U.S. legacy CMBS.