An anticipated month of double-digit CMBS issuance is renewing concerns over laxer underwriting standards and increasing leverage on deals.
“Clearly there’s been an erosion of underwriting and it’s also been exacerbated by the number of originators out there,” said Eric Thompson, a senior managing director with Kroll Bond Rating Agency’s CMBS group.
Over the last several years, LTVs have risen steadily in issues and the number of originators has grown to roughly 40.
KBRA’s stressed LTVs during the first half of 2012 were in the low-90% range, now they are over 100%. If it’s a sign of things to come, a $1.2bn deal JPMorgan Chase & Co. and Barclays Plc issued on 6 Aug. had one of, if not the, highest LTV of any deal since the crisis.
The good news is that this time around credit enhancement levels are rising too, said Nitin Bhasin, a managing director with KBRA, noting that the emergence of new ratings agencies like KBRA has actually helped set a new bar for “quality, transparency, timeliness, and credit enhancement standards.”
Pre-crisis, “AAA” rated classes had a twelve-and-a-half percent credit enhancement, “if you were lucky,” but today “AAA” credit enhancement is in the 20s, the KBRA analysts said.
If ratings agencies had applied the right amount of credit enhancement on pre-crisis deals, “they would have done okay,” Bhasin said.
There’s been about $5bn of CMBS issuance so far this month, with another $6bn or so in the pipeline for the rest of the month, according to Trepp analyst Joe McBride, who noted that the “pipeline is fluid so that could turn out to be a little more or a little less.”
Though Bloomberg earlier this month suggested that the then-$15bn in projected issuance for the month might “overwhelm buyers,” the deals so far – starting with Wells Fargo and RBS’s $1.5bn for WFRBS 2014-C22 – have set a positive tone in terms of pricing. That deal, as first reported by Reuters, priced some 3bp-40bp tighter than previous CMBS deals across its tranches.
In addition, the metrics behind CMBS deals – on a relative basis – remain attractive to investors, said Nik Chillar, a senior managing director with California-based Opus Bank.
“With evaporating supply in the secondaries markets, there’s clearly a need for yield, and the kind of yield people are getting in the “AAA” through the junior end of the stack are relatively attractive,” he said. “People are going to be comfortable with the relative underwriting further down the stack if they’re looking for yield.”
“CMBS has plenty of competition from banks, which tells you how conservative CMBS underwriting is these days,” he added.
Though the $15bn figure is large scrubbed against the roughly $61bn in issuance so far this year, based on Trepp numbers, it pales in comparison to pre-recession CMBS issuance levels: more than $225bn in 2007. And, September typically makes up the slack following August, a normally weak month.
“It may sound like a big number but… right now it seems as if the issuance is being absorbed by the market,” Bhasin said.
As leverage increases and ratings agencies rate more conservatively, “ratings shopping” continues to be a concern. Legally there is nothing to stop it and Rule 17-g5, meant to curb the practice, simply isn’t having its desired effect, Thompson said.
One Morgan Stanley debt analyst, speaking with Bloomberg, called the recent absence of Moody’s in the ratings of the riskiest slices of deals a “canary in a coal mine.” But Moody’s isn’t the only agency issuers are dodging.
“There are a number of deals we haven’t rated because our view wasn’t as favorable as the agencies that did rate it,” Bhasin said. “This is the structure of the market and it hasn’t really changed before and after the crisis.”