S&P CMBS Downgrades A-Coming

Securitization researchers are expecting widespread downgrade action in the short-term commercial-mortgage backed securities (CMBS) space after Friday’s tightening of ratings requirements by Standard & Poor’s. While the rating agency is not yet downgrading the 3,563 CMBS classes from 217 conduit/fusion CMBS transactions it holds on a negative rating watch, S&P is making it clear it intends resolve the status of the bonds within the next few months. The downgrades include CMBS from the 1995 to 2008 vintages, and the greatest concentration is in 2007 with more than 1,000 tranches on CreditWatch negative. The month of June was filled with chatter about how everyone saw this coming. The CMBS market is aching badly and relief in the form of refinancing short-term liabilities seems challenged in light of locked liquidity. “The announcement was largely in-line with our expectations, in both scope and timing, following the release of their impact piece ,” says Merrill Lynch research Roger Lehman. “The biggest changes, between S&P’s originally estimated downgrades, and its current estimate, occurred in the shorter triple-A bonds and the 2005 and 2006 vintages. Fewer of these bonds will likely be downgraded.” The new criteria shift CMBS ratings to reflect the ratings agency’s approach to other bonds, such as US corporates, US municipals, sovereigns, and other areas of structured finance. A forward-looking projection is now in place and considering the extended period of tenancy stress mixed with property value declines; adequate credit enhancement is key to maintaining ratings. “At the core of the approach is the establishment of a ‘triple-A’ credit enhancement level that is sufficient, in our view, to enable tranches rated at that level to withstand market conditions commensurate with an extreme economic downturn without defaulting,” says the S&P explanation on the new methodology. “As a result of this update, we expect that triple-A credit enhancement levels will rise significantly from current levels.” Write to Jacob Gaffney.