Last June, as Standard & Poor's was in the process of changing their rating methodology for CMBS. After 10 months, S&P finally published a new methodology.

 The new IO methodology makes a distinction between newly issued IOs (those rated after the report’s publication) and exiting IOs (those that were previously outstanding).

Historically, CMBS IOs have been rated with the same rating as the highest rated principal bonds (usually triple-A). According to analysts at Bank of America Merrill Lynch, the logic of this is that the priority of IO payments was the same as for those bonds in the waterfall, and should have the same rating. "In other words the rating applied to the priority of payment, not the likelihood of payment," explained analysts.

For new issue IOs S&P has made a dramatic shift in their methodology and go with the proposal they submitted last year. Specifically they would choose assigning a rating based on either: the rating of the lowest class the interest only security is stripped off of or; Single-B (based on some enhancement level constraints)

For newly rated IOs, structured in the same way that deals have been historically put together, the IO ratings will be very low (double-B or single-B).

This change to the traditional methodology does not apply to existing IOs which appear to be grandfathered. S&P said that they will maintain the current rating of existing IOs until all classes that pay principal and interest classes rated 'AA-', or higher, have been retired or downgraded below that rating. When this happens they will withdraw the ratings.

As a result of these changes, S&P withdrew the ratings of 56 IO classes, across 49 deals. These rating withdrawals were mostly concentrated in more seasoned deals.

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