Lenders loosened terms on commercial mortgages originated to be packaged into bonds during the third quarter as sales of the securities surged, according to Moody's Investors Service.
"The signs of erosion in underwriting are worrisome," Moody's analysts led by Tad Philipp said in an Oct. 21 report.
The share of hotels in commercial-mortgage backed securities offerings, one of the riskiest property types, more than doubled to 15.4 percent, compared with 7.4 percent in the prior quarter, according to Moody's. Additionally, the prevalence of so-called interest-only debt rose to 33.6 percent from 21.1 percent in the second quarter. Interest-only mortgages delay principal payments for a portion of the loan term or until the debt comes due, meaning that borrowers build less equity in the property.
Shopping centers and malls, which account for roughly 36.3 percent of deals sold from July through September, had the highest percentage of interest-only loans, with 31.9 percent of the mortgages paying no principal until the maturity date, according to the New York-based rating company.
The relationship between property values and the size of the loans against them was comparable to transactions completed in 2004, one of the last years before standards plunged during a property boom, though a small but growing share of loans echo the market's peak, according to Moody's.
Limited Borrowers Pool
Wall Street banks were competing for a limited pool of borrowers as lenders crowded the $600 billion market and investors snapped up new bonds, spurring looser underwriting. About $8.25 billion in bonds tied to shopping malls, office buildings and hotels were issued from July through September, compared with $3.4 billion during the similar period in 2010, according to data compiled by Bloomberg.
Lenders have ratcheted back originations as the European debt crisis roils credit markets and hampers lending. The pace of issuance will slow for several quarters until volatility subsides, according to Moody's.
"There is clearly a feast or famine aspect to CMBS loan originations," the analysts wrote. "CMBS has the potential to go to zero in a crisis or to $200 billion plus as we saw in the 2006-2007 acquisition boom."
Moody's predicts average sales to be between $50 and $75 billion annually. That forecast represents a "normalized" long-term trend line, Philipp said in telephone interview, and is not likely to materialize in 2012 as lenders pull back.
'Hard to Predict'
"It's hard to predict when normal happens," Philipp said. "Next year it's highly unlikely."
There is a lag of as much as four months between when a loan is made and when it is packaged and sold to investors, he said. Lenders have slowed the pace of new originations to about one-quarter of what they were targeting earlier in 2011, according to Philipp. Some lenders, including Credit Suisse Group AG, have exited the business as volatility erodes profit margins.
The extra yield investors demand to hold top-ranked commercial-mortgage bonds rather than Treasuries soared to 323 basis points, or 3.23 percentage points, on Oct. 4, the most since February 2010, according to the Barclays Capital CMBS AAA Super Duper Index.
Spreads have narrowed to 3.15 percentage points after widening from 2.26 percentage points at the end of July. The spread soared as high as 15 percentage points in the wake of the collapse of Lehman Brother Holdings Inc. in September 2008.
