By Tim Dulaney, PhD and Tim Husson, PhD
Late last week, Reuters reported that the issuance of so-called 'large-loan' Commercial Mortgage Backed Securities (CMBS) has recently spiked and that the increase in volume may be due in part to more lenient underwriting standards. Large-loan CMBS issuance in the first few months of 2013 has already surpassed that of 2012.
CMBSs are created by securitizing a pool of commercial mortgage loans such that an investment in a CMBS is a claim on the future cashflows from the pool of commercial mortgages. Because of the complex nature of the securitization process, investors must rely upon the due diligence of the underwriters of the underlying mortgages. When these standards begin to slip, investors could be put at risk.
Fitch Ratings, one of the few major national ratings organizations, takes issue with the "aggressive assumptions" being made with respect to the loan underwriting. According to Reuters, "Fitch believes the combination of unique property-level attributes, the current low interest rate environment, the prevalence of interest-only loans and aggressive income growth expectations has created a need for extra vigilance amid deteriorating underwriting standards."
Large-loan CMBS are unique in that they are backed by only a single, often very large commercial loan. Reuters uses the example of the Morgan Stanley Capital I Trust 2013-ALTM commercial mortgage passthrough certificates. These certificates are backed by a $160 million mortgage on a mall located 15 minutes North of Orlando, FL. The mortgage is a twelve year mortgage with a five year interest only period with only 14% of the principal amortizing prior to maturity in 2025. Morningstar, Kroll and Standard & Poor's all issued presale reports giving the top tranche their highest ratings. Based on Fitch's ratings criteria, Fitch would not have given their highest rating to the top tranche.
Reuters notes that demand has been strong for these deals even though the default rate has increased for such large balance loans. We'll be interested to see if ratings agencies simply conform to one another to retain business or stick to their guns and require stricter underwriting standards.
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