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Commercial Department: Q&A: Morningstar Credit Ratings LLC: November 2013


Q&A: Morningstar Credit Ratings LLC

Frank Innaurato and Ken Cheng, managing directors, Morningstar Credit Ratings LLC

Commercial mortgage-backed securities (CMBS) were hit hard by the recession.

But high issuances and low delinquencies have marked this year’s recovery in the CMBS market. Will this recovery be sustainable for at least the foreseeable future? To get the answer, we spoke with Morningstar Credit Rating LLC’s Frank Innaurato, managing director for CMBS new issue, and Ken Cheng, managing director for CMBS surveillance.

This past August, CMBS delinquencies reached their lowest level since 2010. Is a recovery finally taking hold?

Innaurato: We are on a path to recovery, and that recovery definitely is taking hold in the CMBS market. There are a couple of drivers behind that recovery. One: The active workouts that are ongoing by special servicers in the CMBS market. Two: The ongoing lending that is occurring by banks in the market, [which] is leading to new securitizations. Three: The maintaining of interest-rate levels that is supporting the overall stability of the market, [which] has allowed for loans to refinance in other avenues by way of commercial banks throughout the markets in the United States and through international avenues, as well. So we have seen a gradual movement over the last trailing 12 months — if not in the last two years — where both the delinquent unpaid balance and percentage continue to go down on a monthly basis. 

What property types are leading the recovery?

Innaurato: There are multiple property types. The primary ones that are driving the recovery are office, retail and multifamily. Multifamily has been performing very well and has been a leading driver of the lending environment. We have been seeing a large amount of the multifamily property type come across our desks by way of lending for new issuance. On the office side, we’ve seen more recently in the last six to 12 months, [including] a larger drop in the overall delinquency rate for that property type in particular, as well as a large amount of workouts for those assets, whereas concern continues to surround retail in general as a property type due to macroeconomic conditions. The overall retail delinquency rate as a whole has continued to drop dramatically in the trailing 12 months. 

Will the trend of declining delinquencies continue in the coming year?

Innaurato: There will be a plateau effect at some point. Our conclusion is that we will continue to see delinquencies fall into 2014 as assets continue to be worked out, but this will be mitigated somewhat by the wave of loans requiring refinance at maturity. We expect, however, that [there will] continue to be a vibrant market for new-issuance transactions, and this will assist with refinance activity. There is a numerator-denominator effect that impacts the overall delinquency rate as a whole. As less delinquencies occur on a monthly basis, yet more new issuance enters the market for CMBS, the delinquency percentage will continue to decline, as well as the overall delinquent dollar amount due to the active workout negotiations by special servicers as a whole. The overall trend of delinquencies will continue for the remainder of this year and into 2014. The X factor will be if interest rates flatten or increase somewhat into 2014. But our overall expectation is that is not what is coming in the near future.

By some expectations, total CMBS issuances may hit $65 billion this year, an increase from about $48 billion in 2012. What drives this increase?

Cheng: I think we are going to exceed the $65 billion number. What I am hearing now is somewhere closer to $75 billion to $85 billion of issuance. The $65 billion number is something that the marketplace consensus had at the beginning of the year. I think we will well exceed those expectations. There were loans that are reaching maturity this year, so there is more demand for refinancing. Also, even though [spreads] widened a bit during the summer, they rallied and came back, providing competitive funding for borrowers. There is a lot of demand for CMBS right now. Relative to other fixed-income products, it provides attractive dollar value.

Recently the Dodd–Frank Wall Street Reform and Consumer Protection Act’s provision related to risk retention and the premium capture cash reserve account was eliminated in a re-proposal. Will this help increase future CMBS issuance?

Cheng: This certainly eliminates one of the concerns. It is not a question of whether or not [its] removal will increase issuance. That is not what it is going to do. The removal is going to lessen the chance that it is going to impact the new-issuance volume negatively. This removes a disincentive for putting these deals together

Innaurato: Morningstar has not taken any public position on the issue at this time, but overall, any time regulatory uncertainty such as this can be removed, we’d argue that it would help parties that are waiting on the sidelines to re-enter the market. While this ruling was particularly burdensome, we do think that it would increase issuance in some form or fashion. However, our view is generally favorable that spreads, wherever they may be, will remain a large driver for issuance on a go-forward basis.


Rania Efthemes is director of content strategy at Scotsman Guide Media. Reach her at (800) 297-6061 or

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