In a report published today, Moody’s Investors Service said that the credit quality of Q1 2014 CMBS conduit issuance is similar to that of late 2005 issuance because of “the protection from term default afforded by current debt service coverage ratio levels, and the lower share of interest-only loans.”

“CMBS 2.0 deals are increasingly backed by higher-risk collateral that requires more credit enhancement,” says Moody's director of commercial real estate research Tad Philipp. “The CMBS industry needs to assess the level of collateral risk it will tolerate, and a risk-moderate enhancement profile is preferable for CMBS to be a reliable long-term source of capital.” 

In the report analysts warned that a CMBS market that matures into a business with high-risk collateral and high enhancement would set the stage for the next downturn.

Leverage in Q4 2013 deals rated by Moody’s increased by 50 basis points to 103.5%. The ratings agency said it expected conduit leverage to increase more in the first-quarter 2013 with quarter of loans sized to about 75% of market value.

The more recent CMBS conduits have also been structured with a higher proportion of subordinate debt. “Roughly one in eight fourth-quarter loans had subordinate debt behind it,” said Phillip. “Subordinate debt requires more credit enhancement to offset the added stress on the collateral.”

Moody’s said last October that it had raised the credit enhancement requirements for the increasingly riskier securitization structure.Credit enhancement levels for deals in Q1 2014 will be nearly 9% to achieve Moody’s ‘Baa3’ rating, 300 basis points higher than the levels necessary for a ‘Baa3’ rating in early CMBS 2.0 deals.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.