Moody's responds to Fitch's critique of a Triple A CMBS rating

Wed May 22, 2013 3:58pm EDT

May 22 (IFR) - Moody's on Wednesday defended its recent Triple A rating on a controversial single-borrower CMBS which was denounced in a one-page critique by its rival Fitch last week.

Moody's said that Fitch incorrectly used a simplified and overly broad definition of "pro forma" income projections as the basis for its renunciation of the top ratings assigned to the CGCMT 2013-375P CMBS offering.

The deal was underpinned by a loan on the prestigious Seagram building on Park Avenue, and was assigned Triple A ratings by Moody's and Kroll. Fitch evaluated the deal but was ultimately not hired to rate it by underwriters Citigroup and Deutsche Bank, because it would only have given the senior tranche a Single A rating.

Pro forma underwriting, an aggressive tactic that was the hallmark of risky commercial real estate lending at the height of the market from 2005 to 2007, bases future property cashflows on often wildly optimistic projections rather than in-place or realized income.

Although many investors agreed with Fitch's view and concerns about the increased leverage in the controversial deal, the Triple A portion of the US$572.9m transaction was increased at pricing last Thursday to US$209m from US$75m due to investor demand.

Spreads on the most subordinated pieces widened considerably, however. The deal was originally sized at US439.75m.

Moody's said that Fitch's critique did not appreciate the nuance between "pro-forma" income, which is an unwarranted projection of property performance resulting in overstated credit metrics, and so-called "sustainable" income, which acknowledges the upside potential in projected rental income if a property has intrinsic value.

Moody's used its "sustainability" analysis in its assessment of the projected income and valuation of the Seagram building. It did not take the underwriter's pro forma projections at face value. Additionally, Moody's discounted those "sustainable" projections to reflect "realization risk", or the possibility that the sustainable valuations and income may not come to fruition.

Moody's said Fitch was short-sighted in relying on so-called "in-place", or current, income on the building.

"Relying on in-place cash flow for valuing properties without considering the unique features of the property will lead to inaccurate conclusions," wrote a team of Moody's analysts led by Tad Philipp, the head of commercial real estate research.

"A simplistic reliance on in-place income misses the credit protection that below-market leases afford, while recognizing too much income from properties with weak business models in which income is likely to decline, such as the income of a C-quality mall, or from properties at the peak of the cycle."

Fitch was not immediately available for comment on today's Moody's report.

Last week Moody's and Kroll told IFR that even they generally thought that the issuer's initial projected numbers for the deal regarding net operating income, occupancy, expenses, structure, and other metrics on the building were way too aggressive.

The two agencies assumed a steep haircut on the building's net cashflow and valuation in order to arrive at their Triple A enhancement levels.

Kroll assumed 17.9% less than the issuer's net cashflow and 46.7% below the appraiser's valuation, according to Eric Thompson, head of CMBS at Kroll.

Meanwhile, Moody's undercut by 10.7% the underwritten cashflow, said Moody's Philipp.