Fitch Revises U.S. CMBS B-Piece Repack Criteria on Higher Loan Default Risk; $8B on Watch Negative
NEW YORK--(BUSINESS WIRE)--Given the recent increases and future expectation for higher U.S. commercial mortgage loan defaults and losses, Fitch Ratings has revised its surveillance review methodology for U.S. CMBS B-piece resecuritizations and has placed 188 tranches from 18 transactions (representing $8.4 billion) on Rating Watch Negative. The total includes $928 million of commercial real estate (CRE) CDO liabilities previously placed on, and remaining on Rating Watch Negative, for performance issues.
Of the bonds placed on Rating Watch Negative, $3.2 billion represent tranches which are currently rated 'AAA' by Fitch. These transactions generally hold over 50% of non-rated first loss and 'B' category or below rated CMBS bonds. The ratings from these transactions are expected to suffer the most severe downgrades. Fitch expects to resolve these rating actions within the next 90 days.
CMBS B-piece resecuritizations (also referred to as first loss CDOs/ReREMICs) are CRE CDOs and ReREMIC transactions that include the most junior bonds of CMBS transactions. CMBS transactions generally contain a sequential pay structure where losses are applied in reverse sequential order. The most junior class of bonds, the first loss bond, absorbs losses before other rated bonds in a respective transaction and is generally not rated. These CRE CDO and ReREMIC transactions contain all or a portion of the non-investment grade bonds from CMBS transactions in which the asset manager, typically the CMBS B-Piece buyer, invests.
Actual losses realized on CMBS loans have been very low for many years. Fitch, like other market observers, anticipates significantly greater delinquencies, defaults, and losses in the underlying mortgages in the coming years. According to Susan Merrick, Managing Director and head of Fitch's U.S. CMBS group, 'Recent headline defaults such as Centro and MBS support Fitch's prediction for CMBS defaults at least doubling in 2008.' While investment grade rated CMBS bonds would remain insulated based on current credit enhancements, the below investment grade classes, generally those contributed to these CDOs/ReREMICs, would be impacted.
As such, Fitch has re-evaluated its surveillance methodology, including a review of the underlying assumptions within the original rating model. The previous rating model afforded significant credit to below investment grade bonds, particularly first loss bonds. In addition, the original methodology was developed to review transactions that did not have significant concentrations by obligor and/or industry. Penalties for significant concentrations in these transactions have been increased.
Fitch expects that unrated first loss bonds will experience a complete loss over time, as many of these tranches have a class size that ranges from 1% to 2% of a transaction's collateral balance. Additionally, Fitch expects that bonds rated in the 'CCC' and 'B' categories will experience a substantial loss in the event of a default given that these are also thin classes.
As a result, the revised methodology generally assumes a 100% loss on any non-rated first loss bond for any rating stress above a 'B'. As assets achieve significant seasoning, they are afforded some graduated benefit to higher rating stresses. Similarly, underlying CMBS assets in the 'CCC' and 'B' category are also modeled to experience significant loss severities upon a default. In addition, higher penalties have been assigned to account for a transaction's concentration within a single industry (CMBS). Based on these changes to the methodology, it is expected that many of the rated liabilities within these transactions will experience multiple notch downgrades.
A breakdown of Fitch's rating actions by current rating category is as follows:
--Current Rating 'AAA';
--$Amount on Rating Watch Negative: $3.2 billion;
--Affected par proportion: 41.1%;
--Affected deals*: 13.
--Current Rating 'AA';
--$Amount on Rating Watch Negative: $1.2 billion;
--Affected par proportion: 63.6%;
--Affected deals*: 14.
--Current Rating 'A';
--$Amount on Rating Watch Negative: $1.4 billion;
--Affected par proportion: 65.2%;
--Affected deals*: 14.
--Current Rating 'BBB' or lower;
--$Amount on Rating Watch Negative: $2.6 billion;
--Affected par proportion: 68.1%;
--Affected deals*: 17.
*there is significant overlap in these figures with many transactions containing multiple tranches on Rating Watch Negative.
A spreadsheet reflecting the complete list of these, and all previous Fitch rating actions with respect to CMBS B-piece resecuritizations, is available for download on the Fitch Ratings web site at www.fitchratings.com. The spreadsheet is located under the 'Structured Finance' header in both the 'CMBS' and 'CDOs' sector pages under 'Special Reports'.
The Fitch-rated universe of transactions classified as CMBS B-piece resecuritizations include 35 CRE CDOs and ReREMIC transactions whose underlying CMBS bonds at the time of issuance were more than 15% rated below 'B-', or 25% rated below 'BB'. Several of these deals, at issuance, did not contain any non-rated first loss bonds.