The preliminary criteria that S&P released in June would result in higher rankings for the three deals that it has rated since then, according to reports distributed to investors by the company. For a $340 million offering of mall debt that Morgan Stanley sold yesterday, S&P said its new methodology would rate the entire deal investment-grade, while the old criteria resulted in $29.7 million of unrated debt.
Wall Street banks have been bypassing S&P’s ratings for commercial-mortgage bonds since the company derailed a $1.5 billion sale by Goldman Sachs Group Inc. and Citigroup Inc. last year by pulling its grades on the securities. Since then, S&P hasn’t rated a so-called conduit deal composed of loans from multiple borrowers, the biggest part of the market, according to data compiled by Bloomberg. The three deals rated since June are linked to single property owners.
“The higher loan proceeds deriving from their proposed underwriting criteria is suggestive of somewhat more lenient treatment,” according to Christopher Sullivan, who oversees about $2 billion as chief investment officer at United Nations Federal Credit Union in New York.
Credit-rating companies determine the value of the properties backing the loans in CMBS using the rent and a so- called capitalization rate -- a ratio of estimated net income to value of the property. In the new criteria, S&P said it would use lower capitalization rates, raising the estimated values.
The new criteria would primarily affect the lower-ranking bonds of the recent deals.
S&P is using lower recovery rates in its model for defaulted mortgages, offsetting the effect of higher property values on ratings, the New York-based company said in a June 4 report requesting comments on its proposal.
Ed Sweeney, a spokesman for S&P, cited the June 4 report stating “more positive rating movements are expected for transactions issued in 2009 or later,” and declined to comment further
“It’s reasonable to assume that cap rates may compress going forward,” said Richard Hill, a debt strategist at Royal Bank of Scotland Group Plc. “That’s what the central banks are attempting to do - engineer an environment where there are lower yields across the board.”
The Federal Reserve has kept its target rate for overnight loans between banks at zero to 0.25 percent since December 2008, and said it expects to keep it “exceptionally low” through at least late 2014 in an effort to spur economic growth.
Still, rising interest rates are one the biggest risks for commercial real estate, Hill said. A rise in rates could eat into property values as capitalization rates rise in tandem, meaning property owners would demand higher returns on their investment. Additionally, loans would be more difficult to refinance at a higher interest rate, Hill said.
During the U.S. housing boom, S&P and its competitors pushed to win business by providing inflated ratings for risky mortgage bonds, according to the Financial Crisis Inquiry Commission and a Senate report last year. That allowed pension funds and other ratings-sensitive investors to pack their portfolios with bonds that later plummeted in value.
Wall Street banks have arranged about $18.5 billion in bonds tied to skyscrapers, shopping malls and hotels this year, down from a record $232 billion in 2007, according to data compiled by Bloomberg. Credit Suisse Group AG forecasts as much as $45 billion in 2012 issuance.
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