Magazine article Mortgage Banking

MBA Letter Details Concerns with S&P CMBS Rating Methodology Proposal

Magazine article Mortgage Banking

MBA Letter Details Concerns with S&P CMBS Rating Methodology Proposal

Article excerpt

The Mortgage Bankers Association (MBA) filed a comment letter on June 9 with Standard & Poor's (S&P), New York, expressing concerns over a proposal that would result in a "dramatic change of direction" in how the ratings agency assesses risks of rated instruments.

S&P issued a request for comment (RFC) on May 26 titled U.S. CMBS Rating Methodology and Assumptions for Conduit/Fusion Pools. The proposal suggests that the appropriate methodology for rating commercial mortgage-backed securities (CMBS) should be based on an aggregation of loan-level assumptions of losses. Loans would be individually assessed based on their level of protection from the impacts of market downturns. It also suggests that stressed losses on individual loans would be modeled and then aggregated up to the bond level.

Much is at stake; if adopted, S&P estimates that the change in methodology could have a significant impact. "Our preliminary findings indicate that approximately 25 percent, 60 percent and 90 percent of the most senior tranches (by count) within the 2005, 2006 and 2007 vintages, respectively, may be downgraded," S&P said.

MBA expressed concern initially that the proposal's comment period was limited initially to only five, and then 10, business days. "The magnitude of the change and its impacts warrant a far more substantive review period," MBA said. "We are also concerned about the implementation plan for the new methodology and the associated impact on the credibility of CMBS ratings that such an action would cause."

MBA noted recent volatility in the CMBS markets, which has caused "universal concern" in the commercial real estate finance industry. Many companies calculate risk-based capital requirements based upon the ratings of their investments, MBA said. Should a large number of investments suddenly incur a negative rating event, many firms would be forced to increase their risk-based capital to compensate for the rating change.

"The ratings produced by rating agencies are not simply investor advice," MBA said. "They are a critical component of the financial system and regulate financial market operations such as capital reserve levels, Federal Reserve 'open market and discount window' transactions and allowable investment activities for institutions ranging from commercial banks and thrifts to life insurance companies and pension funds to the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Particularly in today's market, the implementation of a new rating methodology, especially an untested methodology, should take into account market impacts."

MBA also noted that some MBA members were unable to take a position on the proposal because insufficient information was made available in the proposal. "Once these questions have been addressed, MBA members that have thus far not taken a position on the RFC will have the necessary information to provide their input," MBA said. "However, these members caution that the RFC should not be implemented until a more comprehensive understanding of the proposal and its market impacts have been reached by all market participants."

Finally, MBA said while unprecedented defaults in residential mortgages and other asset classes resulting from the current financial crisis clearly require rating agencies to recalibrate their models, the S&P proposal amounts to a "reconstruction rather than a recalibration of the underlying premises of investment in this sector. …

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