Fitch warns of non-IG exchangeable classes in new CMBS pools

Fitch Ratings is voicing concern over new CMBS lending pools that have non-investment grade (IG) exchangeable classes, something the agency hasn't seen since the financial crisis.

Fitch-RatingsFitch Ratings is voicing concern over new CMBS pools with non-investment grade (IG) exchangeable classes, something the agency hasn’t seen since the financial crisis.

The non-IG exchangeable classes in the $955.6 million Morgan Stanley Bank of America Merrill Lynch Trust 2016-C28, tied to 42 loans secured by 161 commercial properties, particularly concerned the agency.

These classes could create “accelerated downgrade risk and a higher rate of loss given default” by allowing tranche thickness to fall below 1.0 percent, a threshold previously maintained in CMBS 2.0 but commonly breached in CMBS 1.0, the ratings agency noted in a presale report.

“If you exchange those, one loan liquidation could eat through several classes very quickly,” Eric Rothfeld, managing director in Fitch’s US CMBS group, told Real Estate Capital. “You saw this in CMBS 1.0, albeit to a much greater degree.”

In the presale report, the agency gave Class F an expected rating of ‘B-sf’ with a tranche thickness of 1.0 percent. However, if class F were exchanged with class F-1 and class F-2, the tranche thickness would dip below one percent.

Among other concerns relating to CMBS 2.0, Kroll Bond Rating Agency in September voiced concern last year about the rise in “Credit Bar-Belling” among CMBS loan pools, a practice that uses lower leverage loans to compensate for increases in riskier loans.

An examination of KBRA-rated conduits containing investment grade loans showed dramatic, seven-fold increases in high leverage (HL) loans — with LTVs greater than 110 percent — from 2012 to 2015, according to a report from the rating agency. During the same time, the presence of “ultra” high leverage (UHL) loans, with LTVs in excess of 120 percent, had tripled.