Wednesday, July 22, 2009

S&P Commits Professional Suicide With Ratings Round Trip, Underlying CRE Remains Toxic Garbage

Rare? Medium Rare? Medium? Well Done? S&P? Indeed, as the last peg in the gradation of burnt to a crisp, S&P smells completely done. As in there isn't even left a shadow of a doubt that all S&P does is pander to the solicitations of whatever few remaining clients it may have, or, as the case may be, the U.S. government. Any credibility S&P, which one would be excused for confusing with Sycophantic & Pathetic, may have tried to salvage over the past 6 months has been gutted and left to dry after this most recent fiasco, which is the final straw on the McGraw-Hill subsidiary's expedited route to the NRSRO utterly discredited trash heap. From Bloomberg:

Standard & Poor’s backtracked on ratings cuts issued last week and raised the ranking on commercial mortgage-backed debt from three bonds sold in 2007.

The securities, restored to top-ranked status, had been downgraded as recently as last week, making them ineligible for the Federal Reserve’s Term Asset-Backed Securities Loan Facility to jumpstart lending.

S&P lowered the ratings on a class of a commercial mortgage-backed bond offering from AAA to BBB-, the lowest investment-grade ranking, on July 14. The New York-based rating company reversed the cut today, S&P said in a statement. In a related report, S&P said it adjusted assumptions on the timing of projected losses on the mortgages.

“It is a stunning reversal and certainly raises questions concerning the robustness of their revised model,” said Christopher Sullivan, chief investment officer at United Nations Federal Credit Union in New York. “It may engender further uncertainty with respect to ratings outlooks.”

Debt rated below AAA isn’t eligible for the Federal Reserve’s TALF. Investors sought $668.9 million in loans from the Fed to purchase so-called legacy commercial mortgage-backed bonds on July 16, the first monthly deadline to finance the purchase of the securities.

To recap: AAA to BBB- and back to AAA in one week. How many pieces of silver from disgruntled affected CMBS clients (or how many persuasive phone calls from the NY Fed) did it take for S&P to vomit in the face of the few remaining people who had been willing to give the rating agency one last chance at redemption? At this point, nobody cares, just as nobody will ever care again about any bullshit lettering this "rating" agency assigns as an indication of creditworthiness for any entity. For all intents and purposes, undertakers are now shoving S&P's shrivelled carcass deep into the bowels of the credibility morgue where it will remain forever entombed in an unmarked grave, with a final forensic assessment of professional suicide. As expected, nobody will shed any tears of mourning.

Amusingly, S&P's commercial real estate cowardice comes on the heels of a great report issued this morning by CreditSights' REIT analyst Craig Guttenplan titled "REIT 2Q Fundamentals: Protracted Pain Despite Gain." Craig writes:

  • CRE fundamentals for the core domestic property types continued their downward progression during the second quarter with vacancy rates rising and market rents declining as continuing job losses and other negative economic news weighed on both consumer and business sentiment.
  • Despite the weakening in fundamentals, REIT security prices have rallied strongly from the beginning of the second quarter to date on the sector’s re-equitization and deleveraging as well as the broader compression trade due to an improvement in overall credit market conditions.
  • The dramatic upturn in REIT equity during the second quarter underscores how operating fundamentals continue to be a secondary concern to the market’s primary driver of capital markets and liquidity.

And summarizes as follows:

Commercial real estate (CRE) fundamentals for the core domestic property types continued their downward progression during the second quarter. Vacancy rates rose and market rents declined on a national level across-the-board in retail, office, and multifamily as continuing job losses and other negative economic news weighed on both consumer and business sentiment. While this no doubt is negative for the CRE market, it is also not a surprise. CRE fundamentals notoriously lag the economic cycle with their severity and timing driven by how bad the downturn is and how long it lasts.

Surely this alone should be sufficient for S&P to upgrade every CMBS bond possible to AAA and even induct them into the "$1 million sponsor" AAAA club.

In an a dramatic example of what is known as fundamental analysis which in its many years of Simplistic & Parasitic existence S&P never quite got the hang of, Craig provides a very illuminating overview of what is likely the biggest cog in the REIT/CRE/CMBS wheels - expiring leases:

Going along with the consensus view for a near term bottoming of the economic downturn in late 2009 or early 2010, we envision an environment of deteriorating fundamentals that persists through sometime in 2012 or 2013. Given this expectation, we looked at the lease expiration schedule for our retail and office universe to see who is most exposed over this time frame. However, we would point out that the longer duration of these lease types (5-15 years) means that many expiring lease rates are not necessarily going to be significantly lower than when they were originally signed and in certain cases there may still be positive marks-to-market. That said, it is clear that significantly positive marks are no longer going to be the norm or there should at least be some moderation of positive marks relative to more recent periods. For those companies whose portfolios are currently fully marked, lower lease rates should impact revenues more immediately than those with still positive embedded marks.

Despite our expectations for a bottoming of CRE fundamentals in 2012 or 2013, we note that rental rates should remain at depressed levels for the subsequent few years relative to the recent boom period as fundamentals slowly strenghten. So even if a company has a small percentage of its leases rolling during 2009 through 2013, market rents in 2014 and 2015 will likely be lower than market rents in 2006 and 2007 as they recover from their lows. Additionally, while good diversification by most major REITs limits exposure to single tenants, tenant bankruptcies can speed up the lease expiration timetable and force space that was once considered occupied for the longer term back on the market. We note that disclosure around lease expirations can vary by company so our figures are based on what is most readily available in the companies’ quarterly financial supplements.

Needless to say, more reason to upgrade anything and everything that even remotely smells of CRE.

Zero Hedge's advice to Moody's: if you don't want to follow S&P into the NRSRO abbatoir, please run, don't walk to your nearest computer, purchase a CreditSights subscription, and read all of Craig's research pieces on REITs and CRE. Not only will you learn a lot, but you will hopefully avoid S&P's mistake. Alternatively, you can follow in their footsteps, clearing the path for Egan-Jones' unobstructed emergence as the only objective, unopposed, legitimate rating agency in the western world. We await your move with baited breath.

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