New Trend: Is Commercial Mortgage Debt Becoming Threatened Anew By Loose Underwriting Standards?

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CMBS analysts are beginning to see a deterioration in the underwriting standards being applied to commercial real estate borrowers. While standards tightened up after the crisis in 2008, analysts ask if the new loosening of standards could cause commercial mortgage debt to become riskier for investor. As a commercial real estate deal making specialist, the Off Market Association sees the risks and rewards being created by looser lending standards. Commercial mortgage debt creation is definitely expanding, but is still far off of the record $232 billion sold in 2007.

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Much of these newly created commercial mortgage backed securities are being scooped up by hedge funds, who buy the debt with the intention of flipping it.

Bank of America released a report in which it claims the high demand for commercial mortgage debt is leading to looser lending standards. As sales begin to recover at shopping malls, office buildings and hotels, banks and rating companies are competing to win more business, leading to looser underwriting standards for many of the loans in this $550 billion market. Investors looking to add to their riskier bond portfolio holdings should be cautious of these looser lending standards, according to the Bank of America analysts.

“Greater competition among originators and rating agencies increases the risks associated with owning these securities,” according to the New York-based analysts led by Alan Todd.

Much of these newly created commercial mortgage backed securities are being scooped up by hedge funds, who buy the debt with the intention of flipping it. Because the securities have little interest from real investors (those investing for the long term), the debt is prone to volatility and large price swings, sited analysts.

Due to the continuing extremely low Federal Funds lending rate (currently at 0 to 0.25 percent), many money managers who previously held only commercial mortgage bonds rated AAA are beginning to add positions in debt that is rated as low as BBB+ in order to help boost returns. Debt rated lower than BBB+ is primarily being purchased by hedge funds.

This BBB- rated debt has seen yields narrow by 0.50 percent in the past month. This puts the debt at just 4.50 percent above the benchmark swap rate. With narrowing yields, money managers are forced to lower quality standards to maintain returns.

Through October of 2012 there has been roughly $29 billion in commercial mortgage bonds arranged by Wall Street underwriters. Underwritings are increasing, with $7 billion already priced in October. Analysts predict that $45 billion in commercial mortgage bonds may be sold this year. That is an improvement over the $28 billion that were sold in 2011, but a vast shortfall from the record $232 billion in sales recorded in 2007.

About the Off Market Association
The world is changing and has changed. Old ways of doing business don’t always apply. The Off Market Association (OMA) brings a new, exciting and visionary way to do business to all our members. The two affiliates of OMA are Sunovis Financial and Genesis Capital. Members are offering the platforms of these companies for dealmaking, networking and education.

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Kathy Heshelow
Sunovis Financial | OMA
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