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Monday, 04 June 2018

Moody's Warns of Deteriorating Loan Underwriting; Cites Preponderance of IO Loans

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Commercial Real Estate Direct Staff Report

Moody's Investors Service has warned that the volume of loans in conduit deals that don't require amortization for at least a portion of their terms has climbed to levels not seen since before the Great Financial Crisis.

It found that 76.4 percent of loans in conduit deals that took place during the quarter required only interest payments for at least part of their terms. That's the highest proportion of interest-only, or IO, loans since 2007, when 86.9 percent of loans had IO periods.

During the latest period, 48.2 percent of loans were IO for their entire terms, while 28.2 percent required only interest payments for at least part of their term.

The rating agency rated six of nine conduit deals that priced during the period.

Moody's called the increasing proportion of IO loans in conduit pools an "important warning sign of deteriorating underwriting standards." Loans pegged with a Moody's loan-to-value ratio of 85 percent to 95 percent and that had IO periods tend to default, particularly at maturity, at a far greater rate than those that amortize. The rating agency found that the default rate for loans that were securitized in 2007 and had at least some IO period was 19.6 percent. That compares with a 10.4 percent default rate for loans that amortized.

The average IO term during the first quarter was 69 months, up from 67 months in the fourth quarter. While lenders often will reduce the amount of proceeds they'll provide on loans with IO periods, when compared with loans that amortize, Moody's found that the amount of such "pre-amortization," or proceed reduction, was only 2 to 9 percentage points. It said that would be less than the scheduled paydown of comparable amortizing loans.

While many loans against large trophy properties tend to be written with IO periods, Moody's found that most conduit loans that have IO periods were of lesser quality. The rating agency grades properties on a scale of 0 to 5, and places the best quality ones on the lower end of its scale. It found that all of the loans against the best-quality properties were full-term IOs. But the preponderance of partial IO loans increased as property quality declined. A total of 48 percent of the loans written against properties classified as the worst-quality had periods of IO. And 8 percent of those were full IOs.

The rating agency attributed the popularity of IO loans to the healthy competition among loan originators. It noted that loans that have a period of IO are susceptible to "debt-service payment shock" as amortization kicks in and increases the required debt-service payment requirement.

Moody's also warned about the growing share of loans against properties leased to single tenants. Such loans are riskier than those against properties leased to multiple tenants because their fortunes are tied to one tenant. If that tenant leaves at lease maturity, or goes belly up in a bankruptcy and rejects its lease, the property generally won't be able to keep its loan current.

It found that 44 percent of loans against office properties that were securitized during the first quarter were backed by properties leased to single tenants - a rate matched only in 2008. Overall, 29 percent of loans securitized during the first quarter were backed by single-tenant properties, up from 23 percent for all of last year and 22 percent in 2016.

Leverage levels, as determined by the rating agency, which relies on what it views as "sustainable" capitalization rates, were unchanged at 117.3 percent in the first quarter, when compared to the fourth. That compares with the underwritten loan-to-value ratio of 61.7 percent.

A year ago, the stressed LTV level was 118.8 percent, while underwritten LTV was 60.8 percent. And in the fourth quarter of 2015, it was 118.9 percent, while the underwritten level was 65.1 percent.

Moody's said the result of the negative credit trends among conduit loans has prompted it to increase its required subordination levels to 27.2 percent for bonds it would rate Aaa. That's up from 26.8 percent in the fourth quarter. Its subordination level for class-D bonds, none of which it has been hired to rate so far this year, actually declined to 8.1 percent from 8.4 percent. Such classes this year typically have been structured with subordination levels of between 6.25 percent and 8 percent.

Comments? E-mail Orest Mandzy, or call him at (267) 327-4281.


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“The Weekly” is Commercial Real Estate Direct’s PDF newsletter, sent to subscribers every Friday morning. With over 100 news stories published on Commercial Real Estate Direct each week, “The Weekly” features the top stories in commercial real estate that industry participants need to know first. “The Weekly” also contains:

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Additional Info

  • Syndicate to Realpoint: No
  • Subject: CMBS - non-deal specific (CMBS-G), Commercial MBS (CMBS), Mortgages/Financing (MOR)
  • Company: Moody's Investors Service
  • Private: No
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Data Digest







Top Bookrunners Domestic, Private-Label CMBS - 2017
Investment Bank #Deals Vol$mln MktShr%
Goldman Sachs 17.59 11,819.34 13.68
JPMorgan Securities 14.52 10,968.11 12.70
Citigroup 12.04 10,012.71 11.59
Wells Fargo Securities 14.02 9,936.06 11.50
Deutsche Bank 12.55 9,879.74 11.44




cppichart FP



CMBS 2.0 Spreads


Top CMBS Loan Contributors - 2017
Lender #Loans Vol$mln MktShr%
Goldman Sachs 146.89 11,719.34 13.63
JPMorgan Chase Bank 117.68 10,114.14 11.76
Deutsche Bank 198.48 9,689.97 11.27
Morgan Stanley 166.18 8,539.78 9.93
Citigroup 199.05 8,088.24 9.41





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