CMBS Market: 2005 Tough Act to Follow

Despite a string of powerful hurricanes and growing talk of sloppy underwriting, North American commercial mortgage-backed securities (CMBS) posted another solid year in 2005. Not only did issuance hit a record level at $169.2 billion in 2005, but the credit of most CMBS pools both started and ended the year on stable ground.

Standard & Poor’s, the New York City-based ratings agency, upgraded 957 CMBS loan pools in 2005, a level of credit upgrades that represented an 88% increase over 2004. There were eight times as many credit upgrades as downgrades in 2005, which lowered downgrade volume by 28% from 2004. In other words, the number of CMBS pools that saw their credit ratings improve vastly outnumbered the volume of CMBS that actually experienced credit rating declines.

Both ends of the credit spectrum exhibited stability in 2005. A stability ratio is the average percentage of ratings within each category that are not downgraded during a one-year period. Less than 1% of AAA and 4.3% of B-rated CMBS experienced credit downgrades last year.

The stability ratio of B-rated CMBS was even more impressive given its speculative grade characteristics. B notes tend to exhibit more risk than their AAA cousins, making yields higher but losses more likely.

“Looking ahead, there should be fewer upgrades in 2006 than we¹ve seen in 2005. However, upgrades should still outnumber downgrades, as long as the economy continues to grow and real estate fundamentals continue to improve,” reports S & P.

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