Despite properties facing foreclosure, credit agencies continue to assign high ratings to bonds associated with these struggling commercial buildings, according to the Financial Times. This raises serious questions about the reliability of these ratings.

A Concerning Pattern:

Credit agencies have been criticized for misrating over $100 billion in commercial real estate (CRE) debt. This issue is particularly prominent in single-loan mortgage bonds, which have gained popularity due to favorable terms for developers and floating interest rates appealing to investors. Currently, single-loan deals account for about 40% of the nearly $700 billion in outstanding commercial mortgage bonds.

Example Case:

The office and retail building at 1407 Broadway, near Times Square, has seen its value plummet by 73% since 2019, according to CRED IQ. Now in foreclosure, the owner, Shorenstein Properties, has not made payments since July, yet the $187 million in bonds tied to the building’s debt are still rated AA by Fitch.

Detailed View:

Fitch recently downgraded the 1407 Broadway bond from AAA and placed it on watch for further downgrades. AAA ratings indicate an extremely low risk of default; only top-tier companies like Microsoft and Johnson & Johnson in the S&P 500 hold such ratings. Ethan Penner, a pioneer in commercial mortgage bonds, stated, “You should never have a loss on a AAA-rated bond.”

Growing Concerns:

Scrutiny of these ratings has intensified after investors recently suffered a 26% loss on their initial investment in a bond originally rated AAA, backed by 1740 Broadway, the former Manhattan headquarters of MONY. Blackstone purchased the building for $605 million in 2014, but it was recently sold in foreclosure for $186 million.

Why It Matters:

Rod Dubitsky, a former Moody’s analyst, compares the current situation to the pre-financial crisis period when agencies misrated subprime mortgage bonds. Experts argue that single-loan commercial mortgage bonds lack diversification and are therefore less reliable. Furthermore, the Federal Reserve has refused to accept these bonds as collateral for short-term loans. Critics are calling for credit agencies to enhance their rating processes to avoid a repeat of past financial crises.