Moody’s: Post-recession US CMBS credit quality strong, but leverage likely to rise

New York, May 02, 2011 — After two years of no issuance, the credit quality of commercial-mortgage backed securities issued post recession has been strong, says Moody’s Investors Service in a new report. As the credit cycle continues, Moody’s expects the leverage of the loans in transactions to increase, however.

Since issuance resumed in 2010 after the break, Moody’s has rated eight “new generation” or CMBS 2.0 conduit deals. In its latest US CMBS review, Moody’s presents detailed metric analysis of this new issuance.

“Current underwriting is vastly improved compared with CMBS issuance from 2007 contrary to some reports in the market,” says Tad Philipp, Moody’s Director of commercial real estate research. “It is roughly consistent with that of 2004, one of the last ‘normal’ years before frothy underwriting kicked in.”

“In late CMBS 1.0 pro forma underwriting meant stretching for additional income from properties already operating at the zenith of their existence,” says Philipp. “In today’s market, underwriting properties beaten up by the recession may involve trying to get closer to normalized income.”

Moody’s notes that the post-recession deals are “chunky”, that is five or more single loans may each make up more than 5% of a transaction. The lumpiness adds an element of volatility to performance, says Moody’s.

Moody’s also expects loan leverage to increase as credit conditions loosen. Specifically, Moody’s expects a competitive lending market to drive up conduit loan to values (LTVs) to mid-70s percentages, from in the 60s they range in currently.

Favorable commercial real estate conditions should mitigate the credit risk this greater leverage might pose at this time.

“As the cycle advances and the effects of additional leverage become more pronounced, however, it may become necessary to increase subordination,” says Moody’s Philipp.