High Leverage for Apartment Loans Troubles Moody’s

With prices so high for apartment properties, any loan based on today’s appraised values is going to look very large compared to historic prices. But multifamily CMBS loans are especially troublesome, according to Moody's Investors Service.

“The credit quality of U.S. conduit/fusion commercial mortgage-backed securities (CMBS) continues to deteriorate, with conduit loan leverage in the second quarter pushing past its 2007 peak,” reads a July report from Moody’s.

These loans may look relatively modest compared to the appraised value of the apartments properties now. But if prices were to fall, a number of these loans might be in serious trouble. Lending experts argue that problems may be mitigated by stronger loan underwriting standards overall. Also, property prices may have even more room to rise relative to the income from apartment properties, and don’t have to fall anytime soon, as interest rates creep upwards, according to some apartment experts.

“Lenders are holding to pretty good underwriting standards,” says Bill Hughes, senior vice president for Marcus & Millichap Capital Markets. For example, lenders still resist to the urge to offers loans with interest-only periods longer then a few years, unless the loan is relatively low leverage, covering less than 60 percent of the property’s appraised value.

Moody’s: Underwriting way past the peak

The average CMBS loan was equal to 117.8 percent the value of the property in the second quarter, as measured by the Moody’s loan-to-value (LTV) metric. That’s very high–largely because Moody’s LTV compares loans to historic property values, instead of the high values that properties are appraised for in today’s market. The average CMBS loan was equal to 66.4 percent on average of the underwritten value of its property over the same period, according to Moody’s.

“The appraisals on Q2 collateral fully reflect the run-up in commercial property prices to levels that top the pre-crisis peak, while our values use a through-the-cycle approach,” according to Moody’s.

Just to compare, in the third quarter of 2007 the average CMBS loan has an average Moody’s LTV of 117.5 percent on average of the underwritten value of its property over the same period. In response to rising leverage, Moody’s is getting tougher in its CMBS ratings, giving fewer bonds in every CMBS issue the coveted AAA rating because the rating agency expects losses.

“Loans sized to 70 percent of peak values likely will under-perform those sized to 70 percent of trough values, as can be seen by comparing loans from the 2007 peak with those from mid-cycle 2003,” says Tad Phillipp, Moody's director of commercial real estate research.

Sky-high prices

The issue of leverage affects the whole business of lending to apartment properties, not just the CMBS business, because it is driven by high prices for apartments.

Lenders are still avoiding some of the worst practices of the real estate boom, however. For example, lenders still require borrowers to show the expenses from a property on a trailing, 12-month basis, says Hughes. Also, borrowers typically can’t get away with forecasting rents that would justify a larger loan, even though the property has now history of earning those high rents.

“I’m not really seeing any of that,” says Hughes. That restraint makes measurements like a loan’s debt service coverage ratios much more meaningful today than it was during the last boom, when giant loans were made based on rosy projections of high rents and low expenses.

Even though apartment properties are selling at historically high prices, by at least one measure prices have room to rise even further. Apartment properties now sell at average cap rates of 5.5 percent. That’s 320 basis points higher than the yield on 10-year Treasury bonds. Just to compare, in 2006 at the height of the boom, cap rates were just 100 basis points higher, according to Institutional Property Advisors.

Cap rates are likely to get a little closer to the yield on 10-year Treasuries. “As investors seek opportunities in secondary and tertiary markets throughout 2015 and compress cap rates there, the spread nationwide to the 10-year will continue to narrow,” according to Institutional Property Advisors.

Interest rate outlook: Federal Reserve

The benchmark yield on 10-year Treasury bonds is also likely to stay relatively low for a long time. “Even the anticipated increase in the Federal Reserve’s benchmark later this year will likely have minimal short-term effect on long-term rates,” according to Institutional Property Advisors. That’s because the bond markets have expected the Fed to inch rates upwards for a very long time, and there is not much in the latest economic reports to pressure the Fed to act quickly. A strong dollar and low energy prices are helping keep inflation below the Fed’s target of 2 percent. “The Fed has the maneuvering room to adjust rates very slowly,” according to Institutional Property Advisors.

An S&P Ban Seen Having Big CMBS Impact

Word that the SEC may suspend S&P from rating commercial MBS transactions sent a shudder through the sector this week.

CMBS lenders said a ban would have a major negative impact on the single-borrower market, where S&P is the dominant rating agency. CMBS shops would likely have to turn to Moody’s or Fitch, which generally take a harder credit-quality stance on single-borrower deals. That would result in smaller loan sizes or higher interest rates, which could depress CMBS issuance by driving borrowers to other types of lenders or by rendering some acquisitions and refinancings uneconomical.

The secondary-market impact could also be significant if an SEC action voided S&P’s outstanding ratings during a suspension. That could force investors whose guidelines require a rating from a major agency to dump bonds, depressing prices.

Bloomberg reported on Monday that the SEC "is seeking to suspend" S&P from rating CMBS transactions. The news agency added that S&P was holding settlement talks in an effort to avoid the sanction.

Nomura researchers speculated that a ban could last one year. The SEC and S&P declined to comment.

The exact nature of the SEC’s investigation is unclear. In July, S&P disclosed that it was being investigated for possible violations of federal securities laws connected to its ratings and disclosures for six CMBS transactions in 2011. Bloomberg said the SEC was investigating whether S&P "bent rating criteria to win business."

Given the uncertainty about the likelihood, scope, timing and length of any SEC sanction, CMBS lenders said they were taking a wait-and-see attitude for now, continuing to quote loan terms on the expectation that S&P will rate transactions. But they acknowledged that they risk taking losses on loans being warehoused when an SEC action is announced.

Likewise, traders said the Bloomberg report had no immediate impact on prices in secondary-market trading.

S&P has almost disappeared from the conduit market because of a series of missteps since the crash and issuer complaints that its methodology doesn’t produce consistent rating patterns. But that same methodology produces relatively favorable credit-enhancement levels on single-borrower transactions, enabling lenders to write larger loans at lower rates. That has made S&P the dominant agency in that sector, with an 81% market share this year, versus 19% apiece for Moody’s and Fitch. Single-borrower transactions account for one-quarter of overall U.S. issuance.

But if S&P isn’t used, a lower percentage of a loan would qualify for an investment-grade rating. That would force a property owner to either borrow less or use mezzanine financing to make up the difference, increasing the blended coupon.

Lenders said the impact would vary widely from loan to loan, but as examples, they said that leverage ratios might decrease to 65% from 70%, and coupons might rise by 25-75 bp. Borrowers would then have to decide whether to pay the higher cost, borrow less, turn to another lender or not proceed at all.

Senior CMBS executives were glum about the prospect of a suspension. One said it would have "a major impact." Another said it would make "a material difference." A third said it would "cast a dark cloud over the CMBS market."

One veteran in the large-loan market said that profits have already been squeezed by increased lending competition this year. "We’ve been skating on thin ice as it is," he said. "If S&P goes away, it’s going to make this business extremely tough."

"Stand-alone deals will still get done," said another lender, "but it means the whole pipeline will have to get re-priced. If it

happens suddenly, there will be some people who’ll get stuck. They’ll have priced a deal a certain way, then find they have to change directions mid-stream. That’s where the pain will occur."

For the secondary market, the worst-case scenario is that S&P would be forced to withdraw its rating on outstanding bonds. Some buy-side shops have investment guidelines requiring that bonds carry a rating from S&P, Moody’s or Fitch. So if S&P’s ratings are dropped and neither of the other agencies rates the bonds, those investors could be forced to sell.

"If [S&P has] to take all their prior ratings off, that would be a problem," said one CMBS trader. But another trader noted that since the market crash, some institutional investors have dropped the requirement of having a rating from the traditional "big three." And the impact would largely be limited to post-crash single-borrower transactions.

So far, secondary-market prices haven’t been affected. This week, unrelated to the Bloomberg report, an unidentified holder sold about $55 million of single-borrower CMBS rated in most cases by S&P but not the two other major agencies. All of the bonds traded at levels that met or exceeded price talk circulated by dealers.

The SEC’s investigation is believed to stem at least partly from a controversial incident in July 2011, when S&P abruptly withdrew its ratings on a $1.5 billion CMBS transaction that had already priced and was about to settle. The unprecedented action derailed the multi-borrower transaction and caused issuers

Goldman Sachs and Citigroup to lose millions, touching off a firestorm of criticism in the industry and prompting angry issuers to boycott the agency on conduit transactions.

S&P attributed the unprecedented action to the discovery of a possible inconsistency in how its analysts had been calculating the debt-service-coverage ratios for new and legacy transactions.

Federal Housing Finance Agency Unveils Plan to Loosen Rules on Mortgages

For years, politicians, housing advocates and potential home buyers have complained that tight credit policies after the housing market crash have kept too many deserving people from qualifying for mortgages.

Now the government is taking steps that it says it hopes will allow more first-time buyers and lower- and middle-income Americans to get home loans at low rates.

On Monday, Melvin L. Watt, the nation’s chief housing regulator, announced a program offering more reassurances to mortgage banks that fear they could suffer unpredictable losses on the loans they sell to the government.

Separately, he disclosed that efforts are underway to allow borrowers to receive government-backed loans with much smaller down payments than are now required. But contrary to early expectations, he offered few details on such plans.

“We know that access to credit remains tight for many borrowers, and we are also working to address this issue in a responsible and thoughtful manner,” said Mr. Watt, director of the Federal Housing Finance Agency, which regulates the mortgage finance giants Fannie Mae and Freddie Mac.

The move in large part is intended to reassure banks that have had to pay tens of billions of dollars to settle legal cases arising from the housing boom and bust and buy back bad loans sold to Fannie and Freddie. To avoid having to make those payments again, many lenders now demand that borrowers meet stricter requirements for loans, known in the industry as overlays.

“We know that this issue has contributed to lenders’ imposing credit overlays that drive up the cost of lending and also restrict lending to borrowers with less-than-perfect credit scores or with less conventional financial situations,” Mr. Watt said in a speech on Monday to the Mortgage Bankers Association convention in Las Vegas.

Some economists, with mortgage bankers, welcomed the new plan, saying that it, with more gains in the job market and a recent dip in mortgage rates, could put the housing recovery back on track. Ben S. Bernanke, the former chairman of the Federal Reserve, recently told an audience that even he could not get a loan to refinance his mortgage.

“Creditworthy borrowers who have been locked out of the housing market will finally have an opportunity to become homeowners,” said Mark Zandi, chief economist at Moody’s Analytics.

But some housing finance analysts contend that tight credit does not sufficiently explain the weakness in the housing market. Instead, they say, an aging population, stagnant wages and a wariness of taking on new debt have all reduced demand for mortgages.

“The reality is that this is as much a demand-driven drought as it is a credit-driven drought,” said Joshua Rosner, of Graham Fisher & Company, a research firm.

With the new plan, the government is trying to strike a balance between the frenzied years of the housing bubble, when mortgages were approved with little regard for the ability of borrowers to repay them, and the tight grip on mortgages after it burst.

“It requires a lot of fine-tuning to get a national mortgage market that achieves all the objectives we want,” said Stan Humphries, chief economist for Zillow, a real estate website.

To reassure mortgage lenders, the housing finance agency intends to further relax the agreements that determine when Fannie and Freddie may require banks to buy back bad loans. The terms that are being loosened involve loans that show evidence of fraud or other flaws in the underwriting process.

Under the new agreements, for instance, Fannie and Freddie would demand buybacks only when there was a pattern of misrepresentations and inaccuracies in the loans. In addition, if problems are later discovered in loans, the deficiencies would have to be significant enough to have made the loans ineligible for purchase by Fannie and Freddie in the first place.

These changes follow other recent adjustments by the housing finance agency to calm mortgage lenders. But mortgage banks did not increase lending to less creditworthy borrowers.

Now, some housing specialists are more hopeful that the overhaul announced on Monday will prompt the banks to lend more. “It will be helpful in moving the needle,” Jim Parrott, a senior fellow at the Urban Institute, said.

Mr. Watt said he would give specifics in a few weeks about a plan for borrowers that could include down payments of as little as 3 percent.

Borrowers can already apply for low down-payment loans that are backed by the Federal Housing Administration. But housing specialists said that some borrowers who qualified for loans backed by Fannie and Freddie were being directed to the F.H.A., which backs loans that have much higher interest rates.

“You want people to get the loan they qualify for,” said Michael D. Calhoun, president of the Center for Responsible Lending.

Market Volatility Drives Down CMBS Prices

Volatility in the stock and Treasury-bond markets put downward pressure on commercial MBS prices this week.

The 10-year Treasury yield finished at 2.16% yesterday, after falling to as low as 1.86% on Wednesday, as a plunge in the stock market touched off a flight to safety. The yield was down by 12 bp from last Friday and 46 bp from the recent high in mid-September.

The decline caused CMBS spreads to widen this week, for two reasons. First, credit spreads in general rose on concerns about the U.S. economic outlook, the European debt markets and spread of the Ebola virus. Also, investors were insisting on a higher spread to compensate for the decline in the Treasury yield.

Many CMBS buyers require a minimum absolute yield to take down new issues. In the last two conduit deals, the benchmark bonds yielded 3.29%. The long-term super-senior class of a $1.3 billion offering led by J.P. Morgan and Barclays (JPMBB 2014-C24) carried a spread of 83 bp over swaps. The comparable tranche of an $842 million issue led by Citigroup and Goldman Sachs (CGCMT 2014-GC25) priced at 87 bp over swaps.

Because of the drop in Treasury yields, the next conduit offering — a $1.2 billion transaction by Deutsche Bank, UBS, Cantor Commercial Real Estate and Natixis (COMM 2014-CCRE20) — will have to carry a wider spread to match that 3.29% yield. With the 10-year swap yield down to 2.328% yesterday, the benchmark spread would have to be 96 bp to reach 3.29%.

"That says it all right there," one CMBS banker said. "The spread will have to be 10-15 bp wider to get it done."

A pullback by some bond buyers is also putting pressure on spreads, according to one CMBS trader. "It’s a tough ride right now," he said. "Any time you have that kind of Treasury volatility, people put their pencils down and say, ‘Let’s think about what we’re doing.’ "

Virtually no bonds from recent conduit issues changed hands in the secondary market this week. But dealers have widened their bid-ask spreads, indicating that they were willing to buy long-term super-seniors from those deals at spreads of 94-96 bp and sell them for 90-91 bp.

Elsewhere in the new-issue market this week, Colony Mortgage Capital continued to market a $320.8 million securitization of seasoned performing mortgages collateralized mostly by multi-family properties. Bookrunners Credit Suisse and J.P. Morgan circulated price talk of 100-bp area over swaps on the only offered class — $220.6 million of bonds with a weighted average life of three years and a triple-A rating from Moody’s.

Meanwhile, RAIT Financial started shopping a $219.4 million offering backed by 22 floating-rate mortgages on various types of commercial properties. The $126.4 million senior class of 2.4-year bonds is rated triple-A by Moody’s and DBRS. The subordinate classes are rated only by DBRS, including a 2.8-year tranche of junior triple-As. UBS structured the transaction and is running the books with Citi.

UBS and Citi were also pitching a $335 million offering backed by the senior portion of a fixed-rate debt package on the 506,000-square-foot office tower at 1500 Broadway in New York’s Times Square. They originated the 10-year package last Friday, including $170 million of mezzanine debt, on a 50-50 basis for Tamares Real Estate of London. The transaction is rated by Moody’s, DBRS and Morningstar.

Job Alert: CMBS Associate Analyst 1 with Moody's

Listing Info:

Moody's Investors Service is among the world's most respected, widely utilized sources for credit ratings, research and risk analysis. In addition to our core ratings business, Moody's publishes market-leading credit opinions, deal research and commentary that reach more than 3,000 institutions and 22,000 subscribers around the globe. Successful candidates will join our commercial real estate finance (CREF) team in New York, which is responsible for the monitoring of bonds backed by multi-billion dollar commercial mortgage backed securities (CMBS) pools of fixed and floating rate commercial real estate loans. The surveillance team is responsible for maintaining the outstanding ratings of CMBS securities as well as publishing in-depth research on relevant credit issues.

Responsibilities will include analyzing all credit aspects of CMBS transactions, such as; property specific cash flow analysis, financial modeling and formulating and substantiating a credit opinion. Duties include presenting transactions effectively and comprehensively to rating committees and writing accurate and insightful press releases. In addition, the associate analyst is expected to complete various special research projects, develop in-depth knowledge of the CMBS sector and take thought leadership initiatives to enhance our analytics and research impact; as well as analyze and complete Rating Agency Confirmation (RAC) requests. Resumes submitted in Microsoft Word format are preferred.

Thank you for taking the time to express your interest in employment opportunities with Moody's Investors Service.


Requirements

Interested candidates should have a Bachelors or Masters degree in Finance, Economics, Real Estate, Accounting or related field

3-5 years experience in the commercial real estate industry is a plus.

Must be proficient in Microsoft Excel.

The ability to manage multiple projects, work closely with others as well as independently to produce accurate, detailed work in a dynamic, fast-paced environment is a must.

In addition, the individual should have well-developed analytical skills along with strong written and oral communication capabilities.

Prior exposure to commercial real estate credit analysis or valuation is desired.


 To Apply, click the following link:
http://www.bright.com/jobs/job/77790_j3f4m575gk3q089njhg/?bfid=31&job_title=Associate+Analyst+1%2C+CMBS+Monitoring&ref=ziprecruiter&utm_source=ziprecruiter&utm_medium=feed&utm_campaign=masterfeed&subid=z7h54rjjc509e&_zat=UqXFj38AAAEAAEs9OdwAAAAh

Moody's Publishes Request for Comment on CMBS Methodology Update

Summary: Moody's is soliciting feedback on a proposed updated approach to rating CMBS in Europe, the Middle East and Africa.  The proposed change will include the assessment of a minimum yield in analyzing the underlying collateral, to allow for greater stability of Moody's property values throughout the market cycles.  While vague, Moody's also aims to align global default correlation assumptions with those used in the synthetic corporate synthetic CDO methodology.  Moody's projects that the proposed changes will have no impact on current ratings.  The report can be viewed via the link below.

Frankfurt --(Moody's Investor Services)--
Moody's Investors Service has today published a Request for Comment (RFC) seeking market participants' feedback on a proposed update to its approach for rating commercial mortgage-backed securities (CMBS) in Europe, the Middle East and Africa (EMEA).

The report, "Moody's Updated Approach to Rating EMEA CMBS Transactions", is now available on www.moodys.com and can be accessed via the link provided at the end of this press release.

The first part of the report outlines the proposed changes to the methodology, while the second summarises  the complete EMEA CMBS methodology and consolidates the existing methodology reports.

Under Moody's proposed approach, the rating agency will introduce minimum yields into its property value analysis. The minimum yields allow for greater stability of Moody's property values throughout market cycles to mitigate the market value volatility associated with commercial real estate (CRE) prices. Minimum yields will effectively cap Moody's value assessment for a given property cash flow, during peak market situations with low property yields.

Moody's intends to amend the property value stresses implied in its model to consider the increased value buffer that it expects as a consequence of the minimum yield application in peak market situations. The rating agency also seeks to align its global default correlations to assumptions used in its corporate synthetic collateralised debt obligation methodology.

If adopted as proposed, Moody's expects that the implementation of the outlined changes to its methodology will have no rating impact on currently outstanding ratings.

We invite market participants to provide feedback on (1) the proposed use of minimum yields in our approach and (2) the levels of minimum yields that we suggest to use, and make other suggestions for consideration by sending comments before 14 November 2013. Comments should be sent to RFC@moodys.com using the RFC Response Form available on the Request for Comment Topic Page on www.moodys.com.

https://www.moodys.com/research/Moodys-Publishes-Request-for-Comment-on-CMBS-Methodology-Update--PR_284281?WT.mc_id=NLTITLE_YYYYMMDD_PR_284281%3C%2fp%3E