Wall Street Skips Moody’s as CMBS Standards Slip: Credit Markets

Photographer: Scott Eells/Bloomberg

Pedestrians walk past the Moody's Investors Service headquarters in New York. Close

Pedestrians walk past the Moody's Investors Service headquarters in New York.

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Photographer: Scott Eells/Bloomberg

Pedestrians walk past the Moody's Investors Service headquarters in New York.

Wall Street banks that package commercial mortgages into bonds are forgoing a ranking from Moody’s Investors Service on the riskier portions of the deals, a sign the credit grader isn’t willing to stamp the debt investment-grade amid deteriorating underwriting standards.

Moody’s didn’t grade the lower-ranking debt in 9 of the 14 commercial-mortgage bond transactions it’s rated since mid-July, according to Jefferies Group LLC. Deutsche Bank AG (DBK), Cantor Fitzgerald LP and UBS AG (UBSN) are selling a $1 billion transaction this week that doesn’t carry a Moody’s designation for a $64.3 million portion that Fitch Ratings and Kroll Bond Rating Agency ranked the lowest level of investment grade, said two people with knowledge of the deal.

Moody’s absence from the riskier securities in commercial-mortgage deals suggests the New York-based firm is taking a harsher view of the quality of some new loans as issuance surges in the $550 billion market, Jefferies analysts led by Lisa Pendergast said in a report last week. Credit Suisse Group AG’s forecast for $70 billion of offerings this year would be the most since issuance peaked at $232 billion in 2007.

“We have been observing a degradation in credit quality for some time” in the CMBS market, said Stuart Lippman, the chief investment officer and founder of hedge-fund firm TIG Advisors’s securitized-assets fund. “In February, we decided new issuance wasn’t priced appropriately for us to continue to participate.”

Loss Shields

Tom Lemmon, a spokesman for Moody’s, declined to comment on the deals or on its standards, as did representatives for Fitch, Deutsche Bank, Cantor and UBS. Moody’s, which has rated 29 transactions this year, graded the rest of the deal being marketed by those firms, said the people, who asked not to be identified because terms aren’t public.

Moody’s absence from the deal portions “is a testament to the fact that the market is accepting other opinions,” Kim Diamond, the head of structured finance at Kroll, said in a telephone interview.

Commercial-mortgage bond deals can have 10 or more classes that span the rating spectrum from AAA to BB, drawing investors with differing risk appetites ranging from insurance companies to hedge funds, according to data compiled by Bloomberg. As much as 70 percent of the transactions are given top grades, with the bottom classes the first to absorb losses when borrowers default.

‘Steadily Deteriorated’

Investment-grade ratings are a prerequisite for many investors, according to Lippman, who ran securitized secondary debt trading at UBS until 2007.

“Typically insurance companies and traditional money managers are more restricted, and ratings can often determine the depth of demand,” he said. “Although some discredit the rating agencies, if their role wasn’t of value, then issuers wouldn’t pay to have them rate deals.”

Looser lending standards on new offerings are a headwind in the commercial-mortgage bond market, JPMorgan Chase & Co. analysts said in an Oct. 18 report. Underwriting has “steadily deteriorated” in 2013, according to the New York-based analysts led by Ed Reardon.

Deferred Payments

Loans that allow borrowers to defer principal payments for at least part of the term increased to an average 55 percent of mortgages packaged into deals this month, from 41 percent in the fourth quarter of 2012, according to data from Bank of America Corp. That means borrowers build less equity in the property, potentially making it more difficult to refinance.

Delinquencies on all commercial mortgages contained in bonds are falling after surging to records last year, helping fuel demand for the debt. Payments more than 30 days late declined 23 basis points to 9.93 percent this month, according to Morgan Stanley.

Wall Street banks have arranged $61 billion in commercial-mortgage bond offerings this year, up from about $41 billion in all of 2012, Bloomberg data show. Top-ranked securities are yielding 131 basis points more than Treasuries, down from a 2013 high of 143 basis points on July 3, according to a Bank of America Merrill Lynch index data. The debt has returned 0.7 percent this month.

Struggling Malls

“In certain instances there is a bit of credit creep,” Kroll’s Diamond said. “Then you will have a market dislocation of some sort like widening spreads and the loan originators will retrench a bit. As a result, the next wave of deals will have better credit characteristics than the transactions that came before.”

Moody’s said last year it was altering the way it assesses weaker shopping malls contained in CMBS deals, citing a growing number of properties that may struggle to survive.

One factor on which Moody’s takes a stricter view than other rating companies is concentration risk, meaning that if the deal isn’t diversified it will require greater credit protection even if the loans are otherwise conservative, according to a banker who structures the deals and asked not to be identified because talks with the ratings companies are private.

“Moody’s lack of participation in some more recent deals suggests that perhaps they see some of the risks we see,” said TIG’s Lippman.

Loan Warning

Elsewhere in credit markets, federal banking regulators in the U.S. are recommending banks bolster underwriting standards for leveraged commercial loans as borrowing of the high-risk debt approaches levels not seen since before the financial crisis. Bristol-Myers Squibb Co. raised $1.5 billion in its first bond offering in about 15 months. The market for commercial paper in the U.S. expanded by the most in 11 months.

A measure of the health of U.S. financial conditions that declines as the environment weakens rose. The Bloomberg U.S. Financial Conditions Index (BFCIUS), which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, increased 0.02 to 1.52. The index reached 1.57 on Oct. 21, the highest in data dating back to January 1994.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, increased 0.2 basis point to 72.2 basis points, according to prices compiled by Bloomberg. The measure had dropped on Oct. 22 to the least since November 2007 in data that adjust for the effects of the market’s shift to a new version of the index in September.

European Index

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased one basis point to 87 basis points at 11:55 a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan was little changed at 135.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The Federal Reserve and the Office of the Comptroller of the Currency sent letters to some of the biggest banks asking them to avoid originating loans that can be considered “criticized,” or debt classified by regulatory agencies as having some deficiency that may result in a loss, according to people with knowledge of the matter who asked not to be identified because the letters were private. Forty-two percent of leveraged loans were placed in that category this year.

Loans Index

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index was unchanged at 97.75 cents on the dollar, holding at the highest in a month. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 3.75 percent this year.

Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody’s and lower than BBB- at S&P.

Bonds of Verizon Communications Inc. (VZ) were the most actively traded dollar-denominated corporate securities by dealers yesterday, accounting for 3.7 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The New York-based telephone carrier raised $49 billion on Sept. 11 in the largest corporate bond issue ever.

Bristol-Myers Squibb’s issued $500 million each of 4.5 percent bonds due in March 2044 that yield 92 basis points more than similar-maturity Treasuries; 3.25 percent, 10-year securities that pay a spread of 87 basis points; and 1.75 percent notes due March 2019 and paying 55 more than benchmarks, Bloomberg data show. The maker of the blood thinner Plavix last sold debt in July 2012 with a $2 billion offering.

Commercial Paper

The seasonally adjusted amount of U.S. commercial paper climbed $28.2 billion to $1.062 trillion outstanding in the week ended Oct. 23, the Fed said yesterday. That’s the biggest rise since the week ended last Nov. 21.

Corporations sell commercial paper, typically maturing in 270 days or less, to fund everyday activities such as payroll and rent.

In emerging markets, relative yields narrowed 2 basis points to 327 basis points, or 3.27 percentage points, according to JPMorgan’s EMBI Global index. The measure has averaged 312.9 this year.

To contact the reporter on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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