DBRS said there are no changes needed in its CMBS rating methodology because of the current market conditions.
The the rating agency's CMBS methodology and modeling approach have been mean-reverting from inception and included the realistic assumption that real estate is cyclical and that at some juncture, capitalization rates as well as the cost of capital will return to a historical mean.
The CMBS transactions we did not rate frequently had large adjustments to the issuer underwritten net cash flow, upward of 15%, demonstrating the inability of the propertys in-place cash flow to support the existing debt obligations, says Jack Toliver, managing director of CMBS. Recognizing the increased probability of default in and of itself fails to reflect the increased risk unless one recognizes that recoveries are likely to be less on a loan that is 120% LTV than on one that was 70% LTV, based on American Council of Life Insurers and Howard Esaki statistical data.
At the core of DBRS analysis, the agency recognize stabilized in-place cash flow modeling instead of cash flow estimates that may or may not be realized over the loan term. Within the rating agencys CMBS model, probability of default is a measure of the ability of its stabilized cash flow to meet contractual debt service obligations over the term of the loan and support refinancing of the balloon balance in an uncertain economic environment. As a result, the majority of the loans that we evaluated between 2006 and 2008, on a preliminary basis, were identified to contain a higher risk profile under these scenarios.
Furthermore, DBRSs property values recognized that the value of the underlying security
is most important at balloon or in the event of a default within the term. Not only does the rating agency recognize mean-reverting capitalization rates, but our model caps recovery for loans that exceed 95% LTV.
According to DBRS, this analysis is clearly identified in its methodology and consistently applied in its models, which stop analysts from rating the vast majority of CMBS deals issued between 2006 and 2008 since those transactions lacked enough initial credit support.
DBRS thinks that delinquencies within the CMBS will still be rising as the market weathers this severe global economic downturn. Because of this, there will likely be more downgrades in
its CMBS portfolio within the next year and continuing well into 2010 as defaulted loans come to
resolution. Lacking a prolonged collapse in the credit markets and assuming a return to equilibrium and some form of market liquidity, the downgrades will be based on individual loan performance and not a broad-based methodology change, the rating agency said.
It intends to use rating trends more frequently as early indicators for CMBS buyers of the detection of credit changes within the loan pools. This will continue to highlight the proactive real-time surveillance we have always performed on each of the CMBS deals the rating agency rates.