Moody’s Investors Service may soon require more protection against losses in the highest-quality notes in CMBS for them to get a triple-A rating.
Known as senior As, these notes were introduced in the mid 2000s by bankers who were courting risk-averse investors. Today, the senior As typically have a 30% credit enhancement, meaning losses in a transaction have to exceed 30% of its principal before investors in these notes get hit.
All agencies are demanding higher credit enhancement for notes that are the second highest in quality — the junior As — as well as tranches further below the capital structure of a commercial mortgage backed security. But Moody’s been the toughest.
Now it’s the senior As that might face stricter requirements from the agency.
“Given recent credit trends, the time when our Aaa(sf) enhancement exceeds the 30% level that marks the current super senior class may not be far off,” the agency said in a report.
The agency says the loans backing CMBS are getting riskier. Its measurement of loan-to-value (LTV) ratio in deals that came out in Q1 hit 117.1%, a level “just below that of the pre-crisis peak,” the agency said.
Moody’s anticipates that the LTVs of upcoming deals will reach, then surpass, the records hit during the boom.
To shield against this deteriorating quality, the agency has been requiring higher and higher credit enhancement to achieve certain ratings at each level of a CMBS’s capital stack.
The issue is that as the agency has required the junior As to have more credit enhancement. Indeed, in recent deals those tranches haven’t even earned the triple-A that other agencies have given them. Their higher enhancement, however, has narrowed the gap between the junior As and senior As or “super seniors” as some call them.
That “cushion” has shrunk from initially 10 percentage points, to less than five percentage points, and even two percentage points.
Moody’s clearly sees the need for more distance between the junior As and senior As for the latter to remain triple-A. With junior As creeping towards 30%, that number may no longer cut it for senior As.