In 2Q11, the quality of the loans backing CMBS conduits held steady in terms of leverage, although there are already signs of more aggressive underwriting, Moody's Investors Service said in a report released today on its quarterly review.
However, there are already signs of more aggressive underwriting that the rating agency warned could lead to weaker loan pools backing CMBS.
The report also said why the return of super-senior tranches is a credit negative, discussed Moody's rating process generally, as well as details how it deals with the unique cyclical challenges in evaluating hotel financing.
"Leverage levels in the four conduit transactions we rated in the second quarter were consistent with those of loans in 2004 transactions, one of the last healthy CMBS vintages before the crisis," said Tad Philipp, Moody's director of commercial real estate research and author of the
report. "However, we're already seeing signs of credit erosion, as underwriting becomes more aggressive."
Specifically, for the first time in CMBS 2.0, which means CMBS issued after the crisis, the proportion of IO was over 20%. Analysts added that the proportion of loans with reserves in two key categories, which are capital expenditures and taxes, dropped.
Over the quarter, leverage as measured by Moody's LTV rate ranged between 90.0% and 98.2% for individual 2Q11 CMBS conduits, averaging of 93.9%, a slight uptick. Simultaneously,
Moody's debt service coverage ratio (DSCR) rose to 1.48x during the quarter, a slight improvement over the 1.46x of the previous quarter.
In general, Moody's analysts think that the credit quality of CMBS 2.0 deals as having moved through two phases. In the first phase, the 2Q11 and 3Q11 of 2010, Moody's-rated deals had Moody's stressed LTV ratios in the low 80's, as these first post-crisis deals had underlying loans that were very conservatively sized. Since then, Moody's said that in the second phase, leverage has increased to the low 90's, with slightly more aggressive underwriting practices that are consistent with those of about 2004.
Moody's also said that the return of the super-senior structure for the first time in CMBS 2.0, in a offering not rated by Moody's, which underwriters eventually pulled from the market.
"We consider the super-senior structure to be credit negative for CMBS underwriting, because it can reduce so much of the credit risk for senior investors that they may become disinclined to exert much-needed discipline on the underwriting process," Philipp said.
The report also went on to described how the rating agency's CMBS rating process involves both quantitative tools and analyst judgment. It showed how Moody's utilized floor values that represent fire sale pricesto meet the challenges of evaluating hotel credit during stressed or transitional time periods, the rating agency said.