The recent run of lower interest rates may bode well for today's commercial mortgage-backed securities, unless it's undermined by an increase in leverage, according to a new Fitch Ratings report.
"Today's historically low interest rate environment will benefit CMBS performance only if CMBS lenders maintain recent leverage metrics," Fitch Managing Directors Eric Rothfeld and Huxley Somerville said in the report. "Debt service coverage ratios will improve with lower coupons, all else being held equal. However, an increase in leverage, leaving DSCRs at their recent levels, would make the loans more susceptible to refinance risk at maturity due to the increased debt."
The prevalence of recently originated loans at the upper end of the interest rate range suggests that a majority of borrowers are paying a risk premium, according to Fitch.
"Close to 100% of loans in recent CMBS transactions presented to Fitch have mortgage rates below 5%, indicating that it is not solely higher-quality assets benefiting from the lower coupon environment," the analysts said. "Some of the lowest-risk loans have rates below 3%."
Differences in underwriting and interest rates between origination and maturity are a perennial concern for commercial mortgage lenders given the balloon payments that are typically due at the end of their terms.
If the market environment is sufficiently different at maturity, a loan lenders were willing to fund at origination might be one that can't be refinanced at the end of its term.
However, in some instances originating lenders have been willing to lengthen the term of the existing loan. This "extend and pretend" strategy has been a common means of defusing the concern.
Fitch analysts will be incorporating their assessments of the risk in ratings CMBS bonds.
"Current CMBS origination will almost certainly refinance into a higher rate environment than we observe today. Fitch will continue to monitor the impact that the current rate environment has on transactions," the analysts said.
While Fitch and others are concerned the U.S. economy may be overdue for a recession that could hurt loan performance, a recent Mortgage Bankers Association report suggests that based on current economic conditions, the near-term outlook for delinquencies on outstanding CMBS
The volume of commercial and multifamily loans maturing could increase in upcoming years, according to a separate MBA study. That's because the market is exiting the period in which the volume of maturing loans was limited by the fact that the origination years reaching the end of their terms dated back to a period when few loans were made.
