Fitch Sees Room for Improvement in U.S. CMBS Market

Huxley Somerville

While there are many favorable aspects to the general health of the U.S. CMBS sector, some areas could bear improvement, according to Fitch Ratings.

“Everyone wants to avoid the mistakes in CMBS 1.0 and what happened there. There has been as a whole improvement across the board, but there are still a couple of areas that are hangovers from 1.0 that don’t seem to have been resolved,” Fitch Ratings managing director Huxley Somerville told Commercial Property Executive. “They aren’t necessarily easy fixes, and CMBS 2.0 is better, but there are places that could be (even) better.”

Among them, Somerville said, is that as new originators enter the market, there is a need to stretch to get the loans originated. “They are all competing for very much a similar product, and the underwriting gets pushed in the wrong direction, and there’s not a lot you can do about it,” he said. “You want competition and you can’t inhibit the market, but unfortunately, a side effect is that underlying standards decline, and they will decline until there is some sort of correction.”

According to Somerville, a great deal has been made of the underwriting declines in recent years, but in fact CMBS originators are generally exercising prudence and using more sensible assumptions when underwriting a property’s cash flow—a positive development compared to the 2006 to 2008 period.

Fitch’s recent report analyzing the market also identified other areas with room for improvement, particularly around potential conflicts of interest among special servicers and the excessive amount of debt evident in some large-loan deals.

“Increased transparency is still needed on the motivations of some CMBS special servicers in relation to the actions that they take on a loan in need of a workout,” Somerville said. “As for large loans, some of them are just too highly leveraged and may have considerable refinance risk, particularly if interest rates are significantly higher at maturity.”

Of the favorable signs, Somerville feels credit enhancement will increase, something that didn’t occur in the last cycle.

This U.S. CMBS progress report is the first in a series Fitch plans to publish globally that discusses significant changes various sectors have undergone since the financial crisis.