NEW YORK CITY—Although CMBS issuance for 2014 may fall short of earlier projections by as much as 10%, improving fundamentals could mean higher volume next year. However, says Kroll Bond Rating Agency in its outlook report on the sector, a recent trend toward deteriorating credit standards in conduit deals is likely to continue into 2015.

In a year when as many as 40 loan originators competed for market share, “the deterioration in credit metrics was observable across all major property type sectors,” leading to higher credit enhancements, according to KBRA's report, prepared by senior director Terri Magnani and senior managing director Eric Thompson. Among other indicators, loan-to-values rose from an average of 95.4% at year-end 2013 to 101.1% this year, KBRA's interest-only index increased from 26.9% to 33.2% and debt service coverage declined from 1.78x to 1.63x. KBRA says it expects the IO trend to continue “as the economy continues to expand and rates begin to slowly increase.”

Further, KBRA reports that the use of pro forma underwriting ticked up throughout the past year. “Although the use of the practice was not as blatant as it was during the peak of the last cycle, we observed many instances where originators: averaged contractual rent increases for non-credit tenants through the loan term; included rental income from leases out for signature in total base rent; provided credit to income from master leases; and grew hotel RevPAR above the trailing 12-months,” according to the report. It also notes a number of cases in which “issuers provided credit for speculative income growth or reduced expenses that lacked substantive support.”

Even so, KBRA is optimistic that, in view of improvements in the commercial real estate fundamentals of many markets as well as a continued low interest rate environment, issuance could reach $110 billion in '15, or as much as 20% higher than this year's year-end total. It may come in even higher, the rating agency says, “if the economy maintains its current trajectory and interest rates remain as low as they have been” for much of the preceding 12 months.

Notwithstanding the contraction seen in the first quarter, the economy posted “meaningful growth through the remainder of the year,” ending Q3 at 3.9%,” says KBRA. Along with the economic expansion, employment figures scored solid gains throughout the year, as about 241,000 jobs were added in each of the past 11 months, lowering the unemployment rate to 7.0% from 5.8% the year prior.

The increase in payrolls, KBRA says, is “no longer contained in the technology and energy sectors but has broadened over the past year to include healthcare and leisure & hospitality, which contributed to economic growth in many regions of the country.” That bodes well, the agency says, for CRE fundamentals across the country. 

KBRA predicts that as the economy continues to expand, “real estate fundamentals will remain stable across all of the property type segments, many of which will experience flat to modest growth. However, the multifamily and lodging sectors are standouts, having experienced marked gains over the past few years. The performance of these two sectors in many markets is at or above that experienced during the height of the last real estate cycle.”