CMBS crowd squashes underwriting standards

Competition amid new lenders spurs rise in riskier loan types, but the industry remains cognizant of the past, reports Al Barbarino. 

As CMBS originators flood into the market, several metrics tracked by data and research firm Trepp suggest that CMBS underwriting standards are slipping – but not as much as they did during the last market peak.

Prices have shot up, cap rates are falling, there has been a surge in the number of interest-only loans, and loan-to-value ratios are creeping up; all signs that point to loosening underwriting standards.

REC 06.15 - p34 - AInterest-only loans – considered riskier than loans that pay down principal during their term – jumped from 37.3% of new CMBS issuance in Q1 2014 to 57.6% in Q1 2015, data from Trepp shows (see fig 1).

Year-on-year, average cap rates have also compressed across property types, suggesting that lenders are requiring less income per dollar of property value to write a loan, as property prices and competition increases.

But while LTV levels have risen, they have done so subtly. A calculation based on Trepp numbers shows that LTV ratios across all asset types rose just over 2 percentage points, to 63.7%, in Q1 2015, year on year (see fig 2).

The market and behaviour of (most) of its participants today also looks a lot different – and more disciplined – than during the last boom, says Trepp analyst Joe McBride.

“We know values have rebounded and in some cases surpassed ‘07 levels,” McBride says. “But back then it was ‘go-go-go.’ People today are wary and on the lookout for warning signs. That is encouraging.”

REC 06.15 - p34 BRestraint in the market is evident in more stringent and exhaustive reporting standards for CMBS deals, rating agencies’ bolder actions and reports, and caution on the part of investors, even as competition and issuance ramps up, McBride notes.

Total CMBS issuance (including conduit, single asset/borrower and large loan deals) ended Q1 2015 at $25bn, well up the $16bn in Q1 2014, according to Trepp.


“Ratings agencies such as Moody’s are being more stringent and a lot of investors like stricter subordination,” McBride says. “There have been a ton of new entrants into the lending market and a lot of competition for every loan. That is pushing up LTV levels and the number of interest-only loans, but the discipline is on the part of investors and B-piece buyers.

“Even if loans get a little riskier, the whole point of securitisation is to transfer that risk to someone who’s willing to take it,” he adds. “Maybe the B-piece buyers will ask for more return or more subordination. If the market works like it’s supposed to, the added risk will be priced in.”

Loosening underwriting stems from two sides, according to a report McBride wrote for Trepp. On one side, fundamental improvements in property cashflows and values make it more attractive to invest in, and lend on, commercial real estate; on the other, increasing competition to lend and demand for relatively high-yielding CMBS bonds pump more capital into the market, pushing LTV levels up and standards down.

“To what extent each side – fundamental improvement versus excess capital searching for yield – is causing underwriting standards to loosen remains to be seen,” the report says. “The answer may come when rates finally start moving upwards and properties yet to be refinanced have to cover higher debt service payments.”