In response to eroding collateral quality, rating agencies recently have been boosting credit-enhancement requirements — with the result that subordination levels on junior triple-A CMBS have moved closer to the standard 30% threshold for super-senior AAA-rated CMBS. On May 21st, Deutsche Bank and UBS priced a $1.05-billion CMBS offering with junior triple-A subordination of 26.63%. With the COMM offering signaling an acceleration of that trend, the ongoing viability of the senior-junior structure for triple-A CMBS is unclear. In the first quarter, the average junior triple-A subordination level on new-issue transactions was 23.1%, up 2 percentage points from a year earlier.
“When we were buying junior triple-A CMBS this time last year for our client, Country Bank, subordination levels were 20%-21%. The increase in subordination is surprising, but I am glad to see that the rating agencies are responding to the erosion in loan quality and reflecting that risk in higher subordination levels,” said Michael D. Sneden, Executive Vice President at ValueXpress. “With the tightening of spreads and reduction in loan quality, we put the brakes on our CMBS purchases for now.”
“What’s also interesting is our average Class B portfolio subordination from last year at this time is around 14%. Now Class B subordination is in the 18% area and Class C is currently around 14%,” noted Jim Brett, head of CMBS analytics at ValueXpress. “This all means that dealers are selling fewer bonds at lower subordination levels, which negatively impacts profitability. However, CMBS spreads have compressed to more than offset the impact of higher subordination levels.”