The commercial real estate (CRE) market is facing significant challenges, with delinquency rates on office building loans rising in June. Moody’s reported close to $2 billion in losses due to defaults on office building loans, with office vacancies at a record high of slightly over 20 percent. This trend has led to loan defaults in prominent locations such as the Illinois Center tower in Chicago and office buildings in Silicon Valley.
Experts have long warned about the potential risks in the CRE market, with some describing it as a „train wreck waiting to happen.“ Moody’s, a credit rating agency, has come under scrutiny for failing to accurately assess the risks in bonds backed by CRE. Downgrades in commercial mortgage-backed securities (CMBS) have reached levels not seen in recent memory, with 40 deals affected.
Ratings analyst Marc Joffe has filed a formal complaint with the Securities and Exchange Commission against Standard & Poor’s, alleging violations of rules in the Dodd-Frank Act. Joffe argues that S&P is not applying ratings consistently across asset classes, leading to discrepancies in ratings for state debt and CMBS. This inconsistency has implications for state finances and taxpayers, as lower ratings result in higher borrowing costs.
Joffe highlights the case of Single Asset Single Borrower (SASB) securities, which have been popularized in recent years. These securities collateralize a single commercial property, such as a mall or office building, creating a single point of failure. The pandemic has exacerbated the challenges in the CRE market, leading to defaults and downgrades in AAA-rated CMBS.
Despite the growing risks in the CRE market, CMBS issuance continues to rise, including in SASB. Joffe believes that rating agencies like S&P should revise their rating methodologies to better account for risk and ensure uniform ratings across asset classes. However, rating agencies have pushed back against standardization of ratings, citing conflicts of interest and the desire to attract institutional and speculative investors.
Accountability for rating agencies has been a longstanding issue, with the SEC’s decision in 2010 allowing issuers to promote asset-backed securities without including credit ratings in their registration statements. This decision has limited investors‘ ability to hold rating agencies accountable for failures. Efforts to withdraw this decision and subject rating agencies to liability under Section 11 have faced challenges.
In conclusion, the troubles in the CRE market highlight the need for greater transparency and accountability in the rating process. As challenges in the market continue to grow, it is essential for rating agencies to reassess their methodologies and ensure consistent and accurate ratings across asset classes. Investors and regulators must work together to address the risks in the CRE market and prevent future financial crises.