Standard & Poor's has announced, in connection with its advanced notice of proposed criteria change, that it will not be assigning ratings to CMBS transactions that are using its U.S. conduit/fusion criteria.
In this light, the rating agency informed Goldman Sachs and Citigroup Global Markets on July 27 that they would not be able to deliver final ratings for the GS Mortgage Securities Trust 2011-GC4 transaction, for which ratings are a condition to the closing and settlement of the GC4 transaction that was scheduled to price July 28. S&P had previously informed Goldman and Citi that it was prepared to rate the GC4 transaction.
Goldman and Citi as a result have withdrawn the GC4 transaction from the market.
S&P said it has halted ratings to CMBS deals because of the discovery of potentially conflicting methods to calculate debt service coverage ratios (DSCRs). The rating agency will review its application of conduit/fusion CMBS rating criteria with regard to DSCR calculations.
In its latest monthly commentary Annaly Capital Management, a New York-based manager of a portfolio of MBS, analyzed the new round of offerings compared to issuances that came out in 2007.
"Overall the CMBS 2.0 pools have an average debt service coverage of 1.70x. While there was some pressure on the average during early 2011, recent debt service coverage levels have returned to or are above the average. These levels far surpass the 1.31x DSC of GG10," Annaly Capital noted. "Although we have noted some minor slippages, the transactions are still structured with subordination levels that approximate amounts observed with the 2003 vintage, which should provide sufficient credit support."
Prior to 2011, DSCRs used in the S&P criteria were based on the worse of actual debt service amounts and loan constants, Royal Bank of Scotland analysts said. Starting around January 2011, S&P started using a simple average of the two methods in the analysis of new deals, but surveillance continued to use the earlier approach.
S&P issued press releases on July 27 explaining the nature of its internal review, stating that the review may result in multiple technical changes to its conduit/fusion CMBS ratings criteria and indicating that until its review is completed, it will not assign new ratings to transactions based on those criteria, including the GC4 transaction.
"On the individual deal level (GC4), this action might be viewed as negative for both the underwriters and investors," Barclays Capital analysts said in a report. "Specific impact will vary depending on how the hedges were executed on both sides. It is also unclear at this point if the GC4 deal will be eventually brought back to the market and whether its collateral will be fully or partially replaced on top of structural changes."
It is likely that S&P will extend its review of rating methodology to all of the conduits it rates to keep consistency in its methodology. As such, Barclays analysts believe there is potential for some tranches to be downgraded by the rating agency.
"For tranches that are rated by two rating agencies only, and where the current S&P rating is not the lower of the two, that might mean that the second-lowest rating will decline, prompting some selling," Barclays analysts said. Any new downgrades are more likely to be concentrated in new-issue deals and deep in credit for CMBS.1 conduits.
S&P's methodology change could also create more tiering within the new- issue market as deals that have been rated by S&P could possibly start trading wider due to perceived higher risk of downgrade, according to Barclays.
The forecast for the new-issue CMBS 2.0 pipeline for 2011 is also likely to shrink as a result of the reduction of the warehouse pipeline. According to Barclays, originators will be renegotiating loan coupons with borrowers and increased coupons could render certain loans non-eligible for conduits (due to the inability to meet DSCR thresholds).
"Some borrowers might decide to pull back because cheaper funding might be available from other sources," Barclays analysts said. "Some borrowers might decide to refuse conduit financing, switching to alternative sources. For the higher-quality assets that will indirectly benefit insurance companies to the degree there were some assets where conduit platforms were competitive prior to the S&P announcement."
They added that for secondary and tertiary market assets, this might benefit local commercial banks that competed with conduit platforms.