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CRE CLOs gain a fifth credit rating agency: Morningstar

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It’s official: Morningstar Credit Ratings plans to start rating securitizations of short-term, floating-rate loans used to rehab or repurpose apartment buildings, shopping malls, hotels and office buildings.

Commercial real estate collateralized loan obligations, or CRE CLOs, took a beating during the credit crisis but are now one of the hottest products in structured finance. Issuance doubled in 2018 to around $14 billion; Morningstar expects that to rise to $16 billion to $18 billion this year.

CRE CLOs are popular with bridge lenders because they provide matched term funding, and the cost of issuance has fallen substantially over the last couple of years. The sector is a lucrative business for rating agencies, as well as investment banks and securities lawyers.

DBRS, Kroll Bond Rating Agency, Fitch Ratings and Moody's Investors Service also rate CRE CLOs, though Fitch and Moody’s typically rate only the senior tranche of securities issued in these transactions.

In order to rate CRE CLOs, Morningstar had to tweak its methodology for U.S. commercial mortgage bonds to take into account structural features not present or allowable in a conduit, such as the presence of a prefunding account that allows sponsors to acquire collateral after a deal closes and a reinvestment period that allows them to use proceeds from repayments to acquire additional collateral. The rating agency also adjusted its approach to assessing diversity within the CRE CLO transaction.

It announced its proposed methodology on Jan. 7, 2019, and did not receive any comments during a comment period, which ended Feb. 25.

“We are very excited to begin rating CRE CLOs,” said Kurt Pollem, managing director and head of CMBS at the rating agency. “We’re confident in our transparent methodology that market participants can easily understand and apply—one that doesn’t hide behind black boxes or proprietary tools,” he said. “Our criteria incorporates the flexibility to adapt to a rapidly-changing market, and we have a strong CMBS senior team with real-world experience evaluating transitional collateral.”

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