Rating Agency Surveillance of Existing RMBS and CMBS Mortgage Securities: Legitimate "Surveillance," or Changing the Rules of the Game?
National rating agencies, and Standard & Poor's (S&P) in particular, are developing new analytics to be applied to CMBS and RMBS pools originated in the years 2005, 2006 and 2007. As a preliminary matter, it looks like the new criteria will, when applied to the Triple-A tranches, result in downgrades of a substantial percentage of Triple-A CMBS for the three years of issuances reviewed. While the details of the analytical changes have not been made public, investors holding RMBS and CMBS, as well as those with a stake in seeing that the securitization industry be revived in some form (such as the CMSA) are naturally inquiring to S&P about the specifics involved in the analytical changes.
It will be interesting to see if S&P is merely changing the stress assumptions for further declines in the market, or if in fact they are adding new criteria from lessons learned along the way in the financial crisis. Since not all Triple-A CMBS pools have anywhere near the same kind of risk characteristics, perhaps a reexamination of Triple-A CMBS, in order to make meaningful quality risk distinctions between pools, would be a good thing for the market. However, S&P's decision is likely to add more unwelcome investor confusion to the mix.
As most of you know, the Federal Reserve created the Term Asset-Backed Securities Loan Facility (TALF) to help borrowers and lenders as market participants meet the capital credit needs across a wide range of asset classes, including asset-backed securities (ABS), collateralized by auto, student, equipment, credit card, and small business administration loans. More recently, commercial mortgage loans including CMBS were added as an asset class eligible for TALF.
On Tuesday, June 16, TALF offered borrowers the opportunity to participate in one of the first CMBS offerings in a long, long time. The rate available for a loan with an average life of two years was 3.2710% and for five-year, fixed rate loans the rate was 4.130%. Surprisingly, (or perhaps not surprisingly) even in the present capital starved environment, no loan requests were submitted for CMBS/TALF borrowing execution. There could be a number of reasons for this, including continued investors current aversion to risk, particularly in this asset class, a continued belief in future weakening of real estate fundamentals, as well as uncertainty about the precise nature of the TALF execution. At any rate, the last thing mortgage capital markets need is greater uncertainty caused by rating agencies mentioning (but not fully explaining) significant future downgrades of Triple-A CMBS.
This takes us full circle; back to an examination of the fundamental, underlying assumption that criteria can be developed which will adequately assess risk for securitized pools backed by commercial real estate. Commercial real estate investments as an asset class, poses very unique risks and rewards, and arguably are not susceptible to precise bond ratings.
The problem is that rating agencies have taken on the task of providing "on going surveillance" for these asset classes. As S&P collects more information about pool performances, their rating assumptions and general market conditions, they are likely facing a growing need to rerate CMBS pools.
Overall, National Recognized Statistical Rating Organizations risk much by stepping out and being active in the present regulatory/political environment. If they do nothing, they will clearly draw significant criticism. As the need to regulate rating agencies draws increased scrutiny and the possibility of creating federal oversight of these agencies increases, the rating agency should be very circumspect in changing rating methodology midstream and the effect such actions will have on an already dormant market. And it's very difficult to see what type of analytics, when applied to CMBS pools, will shed light on what's happening in the market, given the dearth of reliable activity and data.
Perhaps a better approach would be to simply issue surveillance reports that show specifically what analytics have been employed to arrive at the more generalized conclusion that investors can not rely on the present accuracy of the original rating.
CMBS investors as well as rating agency professionals are invited to comment.
