Credit Markets and Rating Agency 'Refinement'

This is a follow on from my analysis in May into the credit markets and rating agencies, when Fitch assured that it would continue to monitor GGP assets in the context of bankruptcy proceedings (although the implication was for further downgrades).

Rating Agency Antics Fuel Uncertainty
This process continued last month when Standard & Poor's began to tighten their criteria for rating CMBS, with figures quoted as high as $235bn worth of commercial bonds under threat of losing their AAA status.  Now in the WSJ today, Standard & Poor announced that it has just reversed "its evaluation of a clutch of mortgage bonds backed by commercial property." It has re-rated a number which are part of the GG-10 benchmark securitization back to the crucial AAA status required for TALF legacy eligibility - and all just a week after downgrading them.

GG-10 is a large $8bn commercial mortgage backed security bond, that has large numbers of loans resecuritized each year across the market by dealers - so ratings on this baby serve as a bellwether for the health (or problems) of the wider commercial credit market. Looking into S&P's published methodology refinement in more detail, the Fed's desire to support commercial real estate is certainly a possible factor in this turnaround.

If so then that should come as no surprise - the impartiality of rating agencies has always been questionable. Note: for more on this, I highly recommend reviewing this great commentary by Linda Lowell of Housing Wire, on the ratings agencies and their impact on CMBS markets (particularly how S&P could not provide any meaningful backing to JP Morgan analysts regarding their previous change that lead to the downgrades). 

Suffice to say that the late June rally in CMBS resecuritizations was impacted by the ratings downgrade rumours and counter-rumours, as dealers were unable to price with certainty, unsure that triple-A paper classes at the time still would be so for much longer.

What Are S&P Changing?
So behind all this, quoting from the S&P methodology changes announced, the following key aspects are being amended:

• Amending how losses and recoveries resulting from 'AAA' rating scenarios for super-senior classes in US conduit/fusion CMBS are assessed.
• Differentiating the timing of losses from 'AAA' term and maturity default tests when cash flow modelling transactions.
• Spreading out losses that are applied to a transaction's certificates over a longer period of time.
  
  

The latter is the most meaningful change, since it allows for exceptional short-term losses to be effectively averaged, and hence to smooth out rating changes and thus reduce the occurrence of short term rating changes that are subsequently reversed.

S&P Methodology Outlined
For those interested, from Standard & Poor's own paper is the refined 3-step approach that they will be using for rating conduit and fusion transactions:

1. Aggregate recoveries from defaults in the 'AAA' scenario and credit impaired assets up to the crossover date. [NB Crossover date is the time where allocation of principal and losses to the super seniors change to pro rata from sequential]
2. For cash flow modelling, assume loans will not default for 3yrs and apply a 24mth recovery period before losses up to 30% would be applied (at the end of the fifth year). Any additional losses applied the following month, expect losses due to maturity.
3. Use Trepp's cash flow model to apply recoveries through the capital structure of the transaction to determine which certificates had an ending balance of $0, and would therefore retain their 'AAA' ratings.

Credit Market Evolution
This report on Sribd from Deutsche entitled 'The Future Refinancing Crisis in CRE' is another one worth reviewing, to understand the refinancing challenges within CRE right now. 

On a side note, the markets have been changing the structuring of resecuritisation in the last few years, in order to juice up tranches and create more AAA-rated bonds as assets became distressed.  How?  By moving away from the much maligned CDO to re-REMIC's (REsecuritization of Real Estate Mortgage Investment Conduits).

To see how these can be misused, take a look at this crap published by Fannie Mae back in December 2007 - see page 2 for the re-REMIC's section in which they state:

"Market participants know that almost any type of MBS can be used as collateral for Fannie Mae REMICs."

I think we're starting to see part of the problem Fannie, when you openly state almost any MBS will do. How to mortgage the future of the next generation in America through incompetence in one easy step. Let's take a look back at how the process used to work for the banks in the good old days...

"So, if I offer you this enormous stash of our sub-prime mortgage backed securities, you'll give me REMIC's in exchange?", asks the disbelieving banker.

"Sure, we luuurve you guys - you're one of our biggest clients, and we just keep on buying these.. cos.. hell, I don't know but we do. Anyway, the government wants us to buy 'em." replies the Fannie Mae redneck employee.

"I love this job.. ok fine in that case here's $50bn of our worst shit we couldn't sell to Bernie Madoff, and in exchange we'll have those nice AAA-rated Fannie re-REMIC's and sell them onto clients. As a sweetener, we'll even throw in vouchers for you and your family to have a 3 course meal at Cracker Barrel." 

"HELL YES!" replies the Fannie Mae redneck. "If there's Cracker Barrel in the deal, then you've got yourself one."

However back to reality, and re-REMIC tranches are attained in a different way to the particularly special blend of bullshit that the banks came up with previously to produce AAA-grade paper from sub-prime toxicity. Rating levels now are attained with a heavy emphasis on collateralisation - hence why rating changes like today increase uncertainty and problems.

For example, triple-A paper in recent offerings has had the most extraordinary 50% subordination levels; in English that means these would still be AAA rated if half the underlying properties burned down and none of them were insured (which they are). At least in theory, these CMBS are almost unnecessarily safe, thus should not ever be downgraded.

A trader is quoted in a Commercial Mortgage journal as stating that: "The life insurance companies are driving this. For regulatory capital reasons, they benefit from holding bonds that have more ratings stability."

Credit Future
This activity had lead to tighter spreads in the resecuritization market for super-senior bonds, leading to increases in their prices on the market and a general upturn in activity at last. However the junior tranche CMBS going out onto the market still have a significantly higher 30% subordination rate, which is a lot better than the triple-A class deals of old.

To me that is a sign that the quality of the bonds is improving to instill genuine confidence in the AAA-rating once again, and rightly so. Going back to the rating agencies, these sorts of problems then derail such progress by increasing the spreads.

GGP
Despite this, looking back at GGP, this is all part of wider series of moves by the government towards improving the credit markets and is to be welcomed by shareholders as a further means of assisting the firm in restructuring.

Indications continue to be reported that the government is open to reassessing TALF terms and conditions, but these mostly are around an extension to the scheme time frame, not a meaningful change to the criteria. Talking of GGP, there has been little going on besides some arguing between GGP and Hugo Boss relating to the latter wishing to terminate a signed lease early due to delays. Boss are likely to have that dismissed and are just trying their luck with a filing like this.

Otherwise the rulings today are largely unimportant, or have already been made (e.g. around the Success Fee). Somebody needs to slip a bottle of whisky to the good judge and tell him to hurry up and make his decision on the SPE inclusion issue…