Standard & Poor's published refined methodologies and assumptions it uses to rate U.S. conduit or conduit/fusion CMBS transactions.
While S&P's left its property evaluation criteria largely unchanged, the procedure for determining credit enhancement levels represents a considerable update to previous methodologies and assumptions.
At the core of the approach is the establishment of an 'AAA' credit enhancement level that should be enough to allow securities rated at that category to withstand market conditions commensurate with an extreme economic downturn without defaulting.
The the updated criteria's highlight is the specification of an "archetypical pool" and its associated credit enhancement level at the 'AAA' rating category. Under the firm's revised criteria, its analysis led the agency to arrive at a 'AAA' credit enhancement figure of 19% for the archetypical pool.
Rating agency analysts determined the higher enhancement level based on a number of factors, but primarily on their assessment of potential commercial property value drops in the 40% to 50% range under conditions of extreme stress, such as during the Great Depression. This represents a major recalibration of the firm's CMBS criteria and is aimed at making CMBS ratings more comparable with ratings in other sectors, such as corporates, municipals, sovereigns, and other areas of structured finance.
While the new criteria represents a major change in the firm's view of what might happen under highly stressful conditions, it does not mean a change in its view of the expected performance of commercial pools under current conditions. S&P's revised criteria's main focus is on scenarios that its thinks are highly unlikely and that do not reflect its "base-case" expectation, but are nevertheless consistent with achieving S&P's highest rating.
As the rating agency noted in the updated criteria and its report called The Potential Magnitude Of Rating Changes Resulting From Our U.S. CMBS Criteria Update, the agency's revised methodologies and assumptions affect the ratings on 3,563 tranches from 217 conduit/fusion CMBS transactions. Of these tranches, analysts had previously placed its ratings on 1,979 on CreditWatch negative. They placed the remaining ratings on CreditWatch negative on June 26.
Some of the key findings from S&P's analysis of its rated CMBS portfolio are that the projected impact is most significant on recent-vintage or 2005-2008 originated CMBS. The deals from the 2007 vintage will probably experience the most considerable rating changes. Analysts are more likely to downgrade 10-year super-duper senior classes versus those with a shorter WAL.
They might upgrade the securities from some well-seasoned transactions under the updated criteria.
S&P utilizes a Request for Comment (RFC) process to evaluate market perspective before they implement changes to its rating methodology and assumptions. Over the feedback period for the proposed CMBS criteria, it received feedback that was both in favor and against various aspects of our revisions.
During the feedback period, S&P made several key changes to its proposed criteria. These changes reflect input from comments the rating agency received and further refinements of its methodology. The key changes are the archetypical pool previously known as the prototype pool was defined as having an S&P LTV of 90% and an S&P DSC of 1.2x in this article. This differs from the 85% S&P LTV and 1.3x DSC associated with the prototype pool in the RFC.
The firm modified the "incremental" rent stresses found in table 5 of this document from the "additional" rent stresses found in table 4 of the RFC.
Analysts eliminated the top-two loan balance criterion in relation to the 'AAA' credit enhancement floor.
The 'B' credit enhancement floor, which makes up trust expenses or any other small unexpected expenses that might be incurred over the life of a CMBS, has been changed from 1.5% to the greater of 1% and 0.25 multiplied by the BBB credit enhancement level.
The scope of the criteria now applies to a pool of at least 40 loans that is diversified by both property type and geography. In the RFC, analysts stated that the proposed criteria would apply to a geographically diverse pool of at least 20 loans.
Considering the above changes, the criteria's projected impact on the firm's outstanding ratings is different from the projected impact based on the methodology proposed in the RFC.
Generally speaking, the number of downgrades across all vintages is fewer, mainly because of the adjustments to the incremental rent stresses, which resulted in fewer loan defaults under S&P's 'AAA' stress scenario.