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

Updated on
Pedestrians walk past the Moody's Investors Service headquarters in New York. Photographer: Scott Eells/Bloomberg
Pedestrians walk past the Moody's Investors Service headquarters in New York. Photographer: Scott Eells/Bloomberg

Oct. 25 (Bloomberg) -- 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, Cantor Fitzgerald LP and UBS AG 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.

Credit Benchmarks

Elsewhere in credit markets, the cost to protect against losses on corporate bonds in the U.S. and Europe headed for the first weekly increase this month. Wells Fargo & Co. and ABN Amro Bank NV led a doubling of U.S. company bond offerings this week to $35.3 billion.

A measure of the health of U.S. financial conditions that declines as the environment weakens fell. The Bloomberg U.S. Financial Conditions Index, which combines everything from money-market rates to yields on government and corporate bonds to volatility in equities, declined 0.018 to 1.516. 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, fell 0.2 basis point to 72.1 basis points at 11:27 a.m. in New York, according to prices compiled by Bloomberg. The measure is up 0.7 basis point this week, the first increase since the period ended Sept. 27.

Bond Sales

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased 0.6 to 86.7 today and is up 1.8 for the week.

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.

U.S. bond sales increased from last week’s $17.6 billion and compare with a 2013 weekly average of $29.6 billion, Bloomberg data show. Wells Fargo, the largest U.S. mortgage lender, raised $3.5 billion in a two-part issue and Amsterdam-based ABN Amro sold $2.5 billion of fixed- and floating-rate bonds.

Issuance rose after U.S. Congress agreed last week to end the first partial government shutdown in 17 years, removing the threat of a default and helping to push corporate yields to the lowest level since June. The closure trimmed at least 0.6 percent from economic growth this quarter, according to Standard & Poor’s, and could induce the Federal Reserve to postpone paring the pace of its $85 billion in monthly bond purchases until March, economists surveyed by Bloomberg said.

Verizon Bonds

Offerings from banks made up 55 percent of sales this week, as lenders from Citigroup Inc. to PNC Financial Services Group Inc. raised debt after reporting third-quarter earnings, Bloomberg data show.

Bonds of Verizon Communications Inc. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 4.8 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.

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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