As the commercial mortgage-backed securities market matures, the rating agencies that monitor it are sharpening their focus on underwriting standards.
Fitch IBCA has put together an originator review program, which formalizes the agency's consideration of underwriting standards for the securities. Though no other rating agency has used a formal review program, all agree that 1998 will be the year in which the quality of loans backing commercial mortgage-backed securities will betested.
"Capital is about as available as it has been since the peak of the last market," said Tad Philipps of Moody's Investors Service. "We're getting farther into the cycle, and the market is about as good as it gets."
Through its initiative, Fitch conducts on-site interviews with loan originators, evaluates underwriting operations, and reviews procedures and guidelines. The rating agency then tests the policies and procedures against actual loan profiles to verify the integrity of the program.
"We know that they're making riskier loans because of the competition and (these) reviews help us understand what they're doing," said Janet Price, a managing director and head of the commercial mortgage-backed securities group at Fitch.
"It's a competitive market, so we know that they have to compete. There's one big pond of loans, and everyone takes from it," she added.
The initiative underscores mounting concern that-amid historically low interest rates and liquidity ushering huge amounts of the securities to market-competitive pressure is causing underwriting standards to erode.
"We have always seen the need, since the quality of the origination has a direct impact on the performance of the pool over time," Ms. Price said.
"But it was not until they (the underwriters) had developed the programs enough and set the procedures, that we felt that there was something that we can expect."
The market for commercial mortgage-backed securities, which was created in the early '90s by the Resolution Trust Corp., saw a record $44 billion in new issues last year, according to Commercial Mortgage Alert.
As the market has evolved, the role of the rating agencies has become increasingly important. Market participants say Fitch, Duff & Phelps Credit Rating Co., Standard & Poor's and Moody's lend a degree of analysis and foster a flow of information about real estate investments to the public that never existed before.
"It's always important," said Michael Mazzei, head of commercial mortgage-backed securities at Lehman Brothers Inc. "In every year, in every evolution, the rating agencies are challenged to make sure that investors are protected. That is the mandate, and they've been sending the right signals out."
Barbara Chu, a vice president with Metropolitan Life Insurance Co., conceded that "the purchasers of commercial mortgage-backed securities are very focused on the rating agencies."
The rating agencies are "being relied on for determining levels of subordination, underwriting standards, and tranching," she said. "Even those who are originating loans directly look at what the rating agencies are doing because it is competition for them, and could have some impact on an exit strategy or other forms of securitizing debt."
But even while the rating agencies have become gatekeepers to commercial real estate investment, many stress that monitoring underwriting standards is not just the agencies' responsibility.
"All we can do is rate what's going through the door," Ms. Price said. "We can try to respond to what's being brought in. But at the end of the day, it's the bankers that have control over what's being originated."
Added Joe Franzetti, a senior vice president with Duff & Phelps, "The industry should discipline itself. Let's moderate the process, keep the cycles within a tight band. It's within everybody's best interest not to screw up again."
