Moody's has issued a statement that CMBS loans are now almost as risky as in 2007 because 75% of them are interest only, and the interest only period is now 6 years, up from 2.2 years just a few years ago. In addition, they are becoming much more covenant light, and are at higher leverage. All of this is a red flag since these things create much more risk of serious problems when the recession hits. There is also a bigger concentration of single tenant properties, which, as we have seen in retail, can be deadly in a recession. Asset and sponsor quality is also deteriorating. There is now so much competition to put out loans by so many non-bank sources, that borrowers can get lenders to compete, which always means lower quality underwriting. Far too much capital chasing too few good deals.

Underwriting is not nearly as bad as in 2006--2007 yet, but it appears the trend is what it always has been, when the economy is strong and there is too much capital, underwriting standards fall down, and then the stage is set for a bad outcome when the economy goes bad. It is typically 10--12 years between collapse of the last crash and then credit quality deterioration and the next credit collapse. We are at 10 years. Dodd Frank had rules to try to avoid a replay of 2008 in CMBS, but a lot of loans now are made by private equity funds that are not subject to these regulations.

One thing that is immutable is that as each generation comes into Wall Street, they think they know better how to do it, and they eventually do the same dumb loans in pursuit of profits and bonuses. It has never been different. We are not about to have a major crash again, but CMBS loan quality is deteriorating now, and one day in the next 2--3 years, it will be a bad problem. When they start doing a lot of CDOs and virtual CMBS pools with derivatives, then that is a sure sign the end is near.

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