NEW YORK CITY—A little more than a year ago, Fitch Ratings expressed concern over the quality of the underwriting in many of the sizable securitizations that were being announced. “Large loan CMBS deals of late are coming to market with some average assets and aggressive assumptions,” Huxley Somerville, CMBS group head at the ratings agency, said at the time. “In fact, the large loan CMBS landscape is changing so dramatically that Fitch is questioning much of what it’s seeing.” The credit enhancement, Fitch reported, was insufficient to achieve AAAsf ratings.
This year, Somerville and his team at Fitch have a new worry. Although the quality of the properties has improved, the absolute level of debt on large loans issued this year pose the risk now.
Specifically, the ratings agency is concerned that ratings of ‘BBB−sf’ through ‘Bsf’ on a substantial number of 2014 large loan transactions are not warranted given the significant amount of debt at those ratings. In a new report, Fitch says that its wariness is “further reinforced by the amounts of additional debt, subordinate to the first mortgage, that raise leverage on the property and sponsor even further.”
Fitch notes in its report that large loan commercial real estate securitizations represent the most “pure” form of CMBS. “Large loan deals rely first and foremost on the quality of the asset, the strength of the cash flows derived from that asset and the prowess of the owner in maintaining the levels of both cash flow and asset quality,” the report states. “The ability of the sustainable cash flow to cover both the current debt service and the anticipated debt service in the future, after refinance, is critical,” especially in view of the expected rising interest rate environment.
The report reviews a quarter of recent large loan transactions that Fitch did not rate, because the ratings agency felt that the levels of debt and their assigned ratings of ‘BBB−sf’ and below were not warranted. Those transactions are: Wells Fargo Commercial Mortgage Trust 2014-TISH; CGBAM Commercial Mortgage Trust 2014-HD; GS Mortgage Securities Corp. Trust 2014-NEW; and GP Portfolio Trust 2014-GPP.
In the case of WFCM Trust 2014-TISH, for example, the two assets backing the loan—the Westin Times Square and Sheraton Chicago—are considered “well located” lodging properties of good quality. However, Fitch is concerned about competition from new supply, and determined that unpooled tranches of debt on both properties would either have gotten a lower rating than Morningstar and Standard & Poor’s assigned to them or no rating at all.
“The amount of overall debt is sizable and while the loans may perform during their term, very real risks will appear at refinance, leading to possible defaults and rating downgrades,” says Somerville. He adds that absolute debt “is now where we feel extra vigilance is needed for large loan CMBS, and for lower rated tranches in some of these recent transactions there is just too much of it. Additional debt, subordinate to the first mortgage, further amplifies our concerns as it raises leverage even further.”