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Research Announcement:

Moody's Credit quality of US CMBS falls in Q2 2018 as market cap rates hit lows and IO and single tenancy hits new highs

22 October 2018

New York, October 22, 2018 -- The credit quality of conduit loans in US CMBS transactions deteriorated in the second quarter of 2018 as Moody's-determined leverage rose and exposure to interest-only loans and single-tenant occupancy hit new highs, Moody's Investors Service says in its latest quarterly report on US CMBS. And despite the recent rise in the 10-year US Treasury rate, underwritten-implied capitalization rates fell to their lowest average on record.

"Without atypical net operating income growth, rising interest rates leave substantially more room for collateral values of recent vintages to fall than to rise," says Vice President – Senior Analyst, Kevin Fagan. "In the second quarter, rising rates also coincided with declines in debt service coverage ratios for the fourth quarter in a row."

As commercial real estate prices reach new highs, the implied market cap rates used for underwritten property values fell to a record low of 5.87% in the second quarter, Fagan says. The average underwritten LTV fell to 60%, the lowest for conduit CMBS on record, though the adjusted figure would be around 71%, assuming a 100 basis point upward "normalization" of market cap rates.

Loan leverage as measured by Moody's loan to value (MLTV) ratio rose to 118.3% in the second quarter of 2018, while both Moody's and underwritten debt service coverage ratios fell, to 1.64x and 1.84x, respectively.

Meanwhile, the share of conduit loans backed by an office property with major single-tenant exposure climbed to 61% in the second quarter, while for 64% of these loans the largest tenant's lease expires two years after the loan maturity date or earlier. The share of conduit loans with interest-only terms was close to 80%, while the share of full-term interest-only loans rose to 53.6%, the highest share since the beginning of 2007. And for the first time in CMBS 2.0, the MLTV of full-term interest-only loans was higher than that of non-interest only amortizing loans, indicating that "pre-amortization" protection has weakened.

US CMBS credit trends in the second quarter saw the average credit enhancement needed to attain a Aaa (sf) rating rise to 27.6%, Moody's says. The largest divergence of required credit enhancement between Moody's and the market remained at Class D, with Moody's requirement still an average of five rating notches lower than ratings provided in the market and quality dispersion in pools increasing risk to more junior tranches with first loss exposure.

Subscribers can access this report, "CMBS – US: Q2 2018 review – Record low cap rates and high market valuations counteract benefits of lower leverage," at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1131869.

NOTE TO JOURNALISTS ONLY: For more information, please call one of our global press information hotlines: New York +1-212-553-0376, London +44-20-7772-5456, Tokyo +813-5408-4110, Hong Kong +852-3758-1350, Sydney +61-2-9270-8141, Mexico City 001-888-779-5833, São Paulo 0800-891-2518, or Buenos Aires 0800-666-3506. You can also email us at mediarelations@moodys.com or visit our web site at www.moodys.com.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Kevin Fagan
VP-Senior Analyst
SFG
Moody's Investors Service, Inc.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Keith Leung
Analyst
SFG
Moody's Investors Service, Inc.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
SUBSCRIBERS: 1 212 553 1653

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