Though for the very first time CMBS downgrades actually outpaced upgrades in the first quarter of this year, analysts said that Kmart-related rating actions were mostly responsible for the change in the usual trend.

However, even with the Kmart factor out of the way, the results were still not as good as previous quarters, and in the near term downgrades are still expected to trend up and upgrades may not be as forthcoming, analysts said.

Statistics gathered by Greenwich Capital prove these points.

The rating agencies made major rating actions on 221 CMBS classes totaling $8.3 billion. Of this, upgrades only made up 33% by outstanding balance of the actions taken, according to a recent report by the firm.

Greenwich said that the results were somewhat distorted by the number of Kmart CTL classes that went through several rounds of downgrade activity as the ailing company's corporate rating was cut various times before Kmart eventually filed for bankruptcy on January 22, 2002. Analysts said that roughly $5 billion of the downgrades were based partly or exclusively (those involving Kmart CTLs) on both the actual bankruptcy filing as well as events that led to it.

"When the Kmart related downgrades are removed, the CMBS upgrade/downgrade dynamic returns to more normalized levels, with downgrades amounting to only $650 million versus upgrades of $2.7 billion," said the firm's analysts.

Other analysts agree that when you net out the Kmart impact on the lowest-rated classes the picture is more positive, especially considering other factors such as the delinquency rates.

"The rate of increase in the CMBS delinquency rate slowed significantly after a large increase in January," said Darrell Wheeler, a CMBS strategist from Salomon Smith Barney. "We first noticed this improvement in February and now realize that borrower expectations turned positive in January which stanched the delinquency rate increase. Thus while the underlying real estate market may lag in a recovery, borrower actions may actually be a leading indicator.

"Interestingly, while the market fundamentals are getting better the rating agencies only have trailing 2001 data to judge transactions and will err on the conservative side," Wheeler added. "Thus, in the near term the test for a CMBS certificate to be upgraded may be harder while downgrades will likely continue to increase."

Greenwich was also less than positive. The firm said that although the number of upgrades will still outpace downgrades going forward, it would be to a much lesser extent if compared to previous years. Moreover, Greenwich also stated that even without the Kmart effect, the upgrade/downgrade ratio for the first quarter of this year was not as favorable as prior experience. In the last quarter of 2001, for instance, the rating agencies took rating actions on $7.9 billion of CMBS, and only 11% of these were downgrades.

The firm also noted that the remaining downgrade activity aside from those related to K-mart were a result of the events of Sept. 11 and their impact on the lodging industry and insurers.

S&P report

Separately, in a recent report, S&P called the Kmart experience "the most notable and significant rating event during the first quarter." This "significant rating event" caused a considerable amount of Kmart-related downgrades.

According to the rating agency, there were 52 downgrades and only 28 upgrades in the first quarter of 2001. This is compared to 49 raised ratings and only 43 lowered ratings during the last quarter of 2002. Further, the considerable number of downgrades in the first quarter came after a year where upgrades totally overshadowed downgrades. In 2001, there were 174 raised ratings and only 62 lowered ratings.

S&P said the eighteen Kmart credit tenant lease (CTL) deals were downgraded twice during the quarter, which made up 36 of the 52 rating downgrades. These lowered ratings tracked the downward shift of Kmart's corporate credit rating. Aside from the Kmart CTL transactions, two other CTL pools which had a considerable number of Kmart leases were downgraded because of the company's bankruptcy filing and the store closures that followed.

The rating agency also identified 28 other deals - most of which were found in diverse CMBS pools where no store closing affects more than 2.00% of the pool - which had Kmart leases that were rejected. Up to this point, S&P said that none of the transactions had any lowered ratings that were due solely to any of the Kmart store closings.

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