Rating Shopping Presents Opportunities in CMBS

September 10, 2015

Rating Shopping Presents Opportunities in CMBS Photo

Due to concerns in Commercial Mortgage Backed Securities (CMBS) underwriting, rating agencies are requiring increased levels of subordination for junior-rated AAA securities. Citing increasing leverage, lack of amortization, and a higher probability of default, Moody's has required higher enhancement levels for AAA-rated bonds. As a result, Moody's has been excluded from all subordinate conduit bonds since the second quarter of 2015, leaving Fitch as the only major rating agency of fixed rate conduit transactions.

Many traditional investors, such as money managers and insurance companies, cannot invest in CMBS unless it is rated by one of the three major bond raters (Moody's, Fitch and Standard & Poor's). As a result, other investor types, such as hedge funds, have been left to fill the void.

In the chart above, JP Morgan depicts spread levels across ratings for CMBS transactions with and without a major bond rater. Some tiering can be noted, suggesting investors have required additional compensation for lacking a major rating agency. Deals without a major rating agency typically have lower credit enhancement. In addition, collateral characteristics can vary from one deal to the next and should be carefully evaluated.

Key Takeaway: While some major rating agencies have been noticeably absent from subordinate conduit bonds, investors have an obligation to do their credit homework. Regardless of the rating agency, investors should be diligent in their credit analysis. For those investors who are not ratings-sensitive, opportunities may exist to pick up additional yield. For buy and hold investors, the incremental yield pickup may be appropriate for higher-rated subordinate tranches.

Tags: Chart of the Week | Credit analysis | Mortgage-Backed Securities | J.P. Morgan | Fitch Ratings | Moody's | Opportunities

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