BofA Sees Moody’s Shift as Slippery Slope for Real Estate Bonds

At a time of increasingly risky lending in the commercial-mortgage market, Moody’s Investors Service appears to be backtracking on its role as guardian of bond investors, according to Bank of America Corp.

The credit-rating giant surprised the market last week with plans to change the way it calculates default risk in a type of commercial mortgage-backed security. The changes by Moody’s will make it easier for “marginal” firms to borrow potentially excessive amounts based on the values of their buildings, according to Bank of America analyst Alan Todd.

“It seems to be contrary to their comments they’ve made previously,” Todd said in a telephone interview. “It just sets the stage for another leg up in underwriting aggressiveness.”

Moody’s had been all-but shut out by underwriters on grading these kinds of bonds. So the move will likely help it win business.

In the first half of 2015, the firm ranked behind four other credit graders on U.S. transactions that transform giant single mortgages -- such as on a portfolio of hotels -- into a series of bonds, according to data compiled by Commercial Mortgage Alert. Since 2013, Moody’s has fallen from rating 45 percent of these bond deals to 6 percent, JPMorgan Chase & Co. data show.

Too Conservative

The change in calculus by Moody’s, its first major shift since 2000, makes it easier and cheaper for bond issuers to receive top credit ratings. The firm faced criticism this year that it was being too conservative in its approach.

The looser standards also may lead to liberalizations on other types of securities, Todd said, referencing so-called conduit deals in which multiple loans get bundled together. Higher ratings are a key part of what enables lenders to extend mortgages to property investors seeking to buy, sell and refinance real estate investments.

“Our goal is to get the ratings right,” said Thomas Lemmon, a spokesman for Moody’s, adding that Todd was “totally wrong” that the new criteria will result in easier grades on conduit securities.

More Deals

Still, the relaxed standards may increase the number of deals rated by Moody’s, Morgan Stanley analyst Richard Hill wrote Thursday in a note to clients.

During the housing bubble, the widespread practice of so-called ratings shopping fueled a “race to the bottom” among credit graders as they sought to win business, helping to fuel the later financial crisis, according to a 2011 report by a congressionally appointed panel.

“We don’t know until we know if this is going to be a problem,” said Larry White, an economics professor at New York University’s Stern School of Business. “But surely they don’t want to be wrong a second time.”

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