A Credit Analyst Who Rates

Fitch's Mary MacNeill talks with CO about the current CMBS landscape


Commercial mortgage-backed securities have traveled a rocky road during Mary MacNeill’s two decades rating CMBS bonds at Fitch Ratings—or, to be more precise, a smooth road with one very large boulder. When issuance in the sector nosedived during the financial crisis 10 years ago, many wondered whether the asset class would ever again rise to its former vibrancy. Issuance may not have returned to 2007 levels yet, but the 51-year-old College of Saint Rose graduate remains optimistic about the sector’s strength, citing improved underwriting. The New York City-based managing director spoke to Commercial Observer earlier this month about Fitch’s rating process, the shape of the market and what makes a good credit analyst.

SEE ALSO: Interest-Only Loans Back in Vogue Despite Risks: Fitch

Commercial Observer: How did you become a CMBS analyst?
Mary MacNeill: I was in the accounting-financing world, and that’s where I started out at Fitch. I started out at the analyst level and worked my way up. A number of us in the senior staff in CMBS team did that. So, I’ve actually been in the CMBS group for about 20 years.

And how large is your team now?
I’m responsible for a group of about 20 analysts.

What was CMBS like in the early days? Were deals any less standardized?
CMBS did a very good job of normalizing or standardizing the reporting package from early on. I was involved in some of those discussions, as far as what [information] needs to go into what is now the Commercial Real Estate Finance Council’s investor reporting package. But the industry was certainly growing—it wasn’t as established as it is now.

Tell me about some of the challenges of rating structured finance deals, compared with corporate debt, which had long been your industry’s bread and butter.
I think one of the challenges that we’ve always faced is to ensure that a BBB [rating] in corporates is the same as a BBB in structured finance. And that question comes up pretty often: the consistency among the ratings and the meaning of the ratings.

Consistency means that a given rating denotes the same likelihood of default in all sectors?
Yes, it would be the same default probability.

How does Fitch make that happen?
We go through a pretty rigorous process in looking at our criteria every year, and post-crisis, the process around it has become much more formalized. We have different groups who oversee the development of our models and our criteria and the associated backtesting. We go through an entire process each year to provide backup for how we got to certain assumptions that are integral to our criteria. We publish a new criteria report every year. That doesn’t necessarily mean we change the criteria, just that we refresh the backtesting that we’re doing.

What was it like covering this sector during the financial crisis?
For a while, everyone had been questioning whether we were in a bubble. There was a lot of issuance in 2006 and 2007. That probably [lasted] until the crisis with Lehman happened, in August of 2007, when issuance just really fell.

What was the outlook for the future of the market at that point?
I think there was certainly a feeling that the market wouldn’t come back. There were mixed views on would it come back at all, or [whether it] would come back much smaller. As we’ve seen, it certainly has come back much smaller—to a more normalized size. There were a lot of conversations in the industry around, “What if the market doesn’t come back?” And I think that still is a conversation today. Borrower satisfaction is a big topic. I think that’s one of the reasons that people have focused on how we can tighten language in the deals and how we can bring more discipline into the entire process so we don’t fall back to the same crisis level.

How has recent regulation affected the pace and quality of business?
The regulatory side has its plusses and minuses. But I think there has certainly been some self-discipline within the industry to keep the industry going. The industry is self-disciplined. But there are fewer originators today than even a few years ago, and some of that is regulatory. With the regulation that a senior manager has to sign for the deal, originators have certainly dropped off. We had a high of about 40 [originators], and now we’re down to 20 or fewer.

Did the crisis lead Fitch to significantly re-evaluate ratings criteria?
There haven’t really been significant changes to the criteria themselves. What has improved is the discipline around the cash-flow analysis. As I said before, pro forma income is a good example. Now, we have outside people sit in on our credit committees, both on our ratings decisions and on our criteria development.

And you continue to surveil deals annually?
At a minimum. Once the deal closes, it comes over to the surveillance side. Hopefully there are no delinquencies or changes in the pool. We’re monitoring over time for delinquencies, transfers to special servicing, and then year over year, we’ll look at how the cash flow and the underlying properties fluctuated. We focus a lot of our time on the larger loans in the pool—the top 15 especially. We go through and compare what it looked like at origination, how we looked at it from origination and how it performed over time. And then we look at overall pool-level losses.

What were the biggest trends of 2017?
Delinquencies have been down. But when we talk about delinquencies overall for the market, we separate CMBS into 1.0 and 2.0—1.0 being pre-crisis and 2.0 being deals after that. As far as 2.0, the deals have been pretty stable over time. We really don’t see a whole lot of term default risk. Any risk we do see is more at maturity. Interest rates have been low. So the delinquencies and the defaults that we’ve seen—and most of the rating movement—has appeared on the 1.0 transactions.

Many of those downgrades were to the already distressed classes, and the upgrades were more to the top of the stack. Some of those had maybe been downgraded before, and had better-than-expected recoveries, so they were upgraded. In some cases we have defeasance that covers a good percentage of the pool, so we would have upgraded the top because that’s what you’re left with. And on the 2.0 transactions, we only had a little bit of upgrades and downgrades on two transactions this year, where we had two malls that had got into trouble.

I would imagine that retail is a significant concern for you.
There’s definitely a shift in consumer spending. Clearly the malls in locations where they have other competition, those are probably the most of concern and the easiest ones to identify as being of concern.

How important is a mall’s location and nearby competition?
There are a number of malls that are out in tertiary locations that, if they lose their anchors, could be of concern. That’s especially true if you have an operator that doesn’t have the deep pockets to revitalize the area or if you don’t have the demographics to support the size of the mall. The better operators are able to redevelop the malls and put in more entertainment concepts. Make the mall more of an experience as opposed to retail shopping. Online shopping will continue to make up a bigger percentage of overall sales.

In past coverage, we’ve seen sentiment that industrial properties are gaining prestige.
Industrial has never been a large segment of the overall population. I don’t think it has increased significantly. We look closely at where [the site] is—is it close to enough transportation hubs? [But industrial] hasn’t really had a big impact up to this point.

Do trends like that inform ratings analysis—or does your analysis of the fundamentals guide your thinking about the big picture?
We have meetings quarterly to discuss trends within each of the property types, so that might frame how we might look at deals. For hotels, we’ve been concerned about overbuilding and being at a peak for quite a while now, so we’re scaling back our revenue-per-available-room benchmarks to 2014 levels. With multifamily, we [think it might be] at or near its peak, and we’ve been scaling back cash flow to 2016 levels.

So the trends inform the standards that you compare the data against?

What are Fitch’s takeaways from the first year of risk retention?
We’re credit neutral on risk retention. That doesn’t factor into our analysis, and we usually don’t know what structure [the transaction] is going to use for risk retention until the deal is close to closing. But we have seen a slight improvement in underwriting in 2017, so that could be influenced by risk retention. It’s kind of early to tell at this point.

Do memories of the crisis continue to drive underwriters to be more conservative than they were 10 years ago?
I think people have short memories. I think the crisis is kind of awhile [ago] now. That’s why we’ve been credit neutral on risk retention.

How do folks find their way into your line of work?
I think the real estate aspect of CMBS is really what drives people to be interested in it. It’s a more tangible asset. I think that that’s a big plus for people. On the new deal side, we go out and see a lot of the properties, so they get to go out and travel. I think that’s very appealing.

What do you have your eye on for 2018?
A lot of the same trends that we were looking at for this year will probably carry over into next year. Concerns with multifamily and hotels continue to [catch our attention], and retail will obviously be a concern. We’ve seen less of that in the newer deals. Of course, we’ll continue to stay on top of the credits.