02 Jul 2009, Mark Pengelly, Risk magazine
On July 26, New York-based Standard & Poor’s published updated criteria for rating CMBS, which are expected to invoke a swathe of downgrades, particularly among AAA-rated tranches. The reassessment reflects the rating agency’s view that the most senior notes should be able to withstand an extreme economic downturn without defaulting, it said. S&P has a total of 3,563 individual ratings on watch for a downgrade across 217 deals.
The impact of the change in criteria is expected to be particularly severe on more recent highly rated transactions and those with longer maturities. Sixty percent of all AAA notes originated in 2008 and 65% from 2007 will see their ratings drop, respectively. For 10-year super-senior AAA tranches originated in 2007 and 2008, this proportion rises to 95%.
“The damage was much worse than many investors had hoped,” remarked Vishwanath Tirupattur, credit strategist at Morgan Stanley in New York.
The expected downgrades will prove a setback to efforts by the Federal Reserve Bank of New York to reinvigorate the market for existing CMBSs. Under the rules of the Term Asset-Backed Securities Loan Facility (Talf), which provides cheap financing for investors looking to buy asset-backed securities, eligible bonds must be rated AAA and cannot be on watch for a downgrade. “This will shrink the universe of Talf-eligible CMBS quite significantly,” said Tirupattur.
This has led to speculation the New York Fed might loosen the rules of the programme to include CMBSs that were once rated AAA, he said. Another alternative would be the acceptance of restructured CMBSs into the Talf, he added.
On June 16, the New York Fed announced no-one had subscribed to its inaugural offering of cheap funds under the Talf for existing CMBS. It will commence a second on July 16.
In light of moves by S&P, some dealers have sought to make existing CMBS more palatable to investors by restructuring them into resecuritisations of real estate mortgage investment conduits – or re-Remics. This involves splitting existing CMBS into new tranches with fresh ratings. More senior pieces carry lower yields but have greater ratings stability, while junior tranches are left with a greater level of risk in return for higher yields. “Hedge funds will likely have a demand for the more junior re-Remics. The more senior bonds might be attractive for investors such as insurance companies,” said Tirupattur. Depending on their structure, they might also provide regulatory capital relief for banks and insurance companies.
The practice has previously been widespread in residential MBS, with more than $70 billion of deals restructured into re-Remics since the end of 2008, according to Tirupattur. In CMBS, an initial restructuring by Morgan Stanley over the previous month has so far precipitated five other deals.
“There is clearly a demand for these things, but if they become Talf-eligible, that demand will multiply,” he predicted. However, even if the rules for the programme go unaltered, the prospect of further restructurings had helped calm the market, he suggested – something that could reduce the need for cheap funds from the Talf.