Tuesday, May 26, 2009

S&P To Downgrade Most Of 2005-2008 CMBS Classes, Derails TALF For CMBS

The lives of the CMSA and Chris Hoeffel are about to get a whole lot more complicated. In a report issued today by S&P, titled "U.S. CMBS Rating Methodology And Assumptions For Conduit/Fusion Pools" Standard & Poors is issuing a Request For Comments on 'its proposed changes to its methodology and assumptions for rating U.S. commercial mortgage-backed securities." Aside from the RFC, S&P goes into detail what the changes to its rating methodology will be, and the impact from these on CMBS. The latter will immediately cause many headaches for all who rode the CMBS AAA train from 1,200 bps to 600 bps, and potentially start a selling puke shortly. In S&P's own words:
Impact On Ratings

It is likely that the proposed changes, which represent a significant change to the criteria for rating high investment-grade classes, will prompt a considerable amount of downgrades in recently issued (2005-2008 vintage) CMBS. Classes up through the most senior tranches of outstanding deals (so-called "A4s," "dupers," or "super-duper seniors") are likely to be affected. Our preliminary findings indicate that approximately 25%, 60%, and 90% of the most senior tranches (by count) within the 2005, 2006, and 2007 vintages, respectively, may be downgraded. We believe these transactions are characterized by increasingly more aggressive underwriting than prior vintages. Furthermore, recent vintage CMBS, particularly those issued since 2006, were originated during a time of peak rents and values, and as such, may be more affected by the proposed rental declines discussed in this RFC. We are currently evaluating the impact of the potential criteria changes on conduit/fusion CMBS transactions from all vintages. Once we evaluate the potential impact on existing ratings, we expect to issue a follow-up publication to this RFC.
And all this just days after the government had finally drafted what it hoped was the last and final version of its TALF term sheet. Lets rewind: in the May 19th version of TALF, in order the be eligible, CMBS "must not have a rating below the highest investment-grade rating category from any TALF CMBS-Eligibile Rating Agency." Throw in a downgrade of 90% of the 2007 vintage and it's time to go back to the drawing board.

Basically, the impending downgrade would make Super Duper CMBS ineligible for TALF. And as Zero Hedge pointed out this weekend, the collapse in all (especially AAA) CMBS spreads was predicated upon the successful implementation and execution of TALF. Now, as S&P rates about 84% of the CMBS universe, the unintended consequence of a rating agency demonstrating a little character and integrity, stands to throw the entire TALF plan into a tailspin, as even with the most recent amendments, almost all Legacy CMBS issues would become ineligible.

But have no fear: Chris Hoeffel is furiously drafting memoranda as he is squealing how this little development will destroy the universe as we know it. It is a safe bet that the Fed will come back as soon as a week from today and announce TALF 364.7, in which the requirement for a current AAA rating is eliminated altogether. In fact, as I speculated (jokingly), anything rated Default or higher will soon be perfectly eligible collateral for taxpayer funding. Because that's just how good a fiduciary of taxpayer money the Federal Reserve is. Sphere: Related Content
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