NEW YORK, May 17 (IFR) - Fitch shook up the US
securitization market this week when, on the eve of a
long-awaited US SEC public roundtable on credit rating industry
reform, it issued an unsolicited comment lambasting the Triple A
ratings given by two of its rivals to a new single-asset
commercial mortgage-backed security (CMBS) linked to a trophy
Manhattan office building.
For the first time ever in the US CMBS market, the
unsolicited write-up was released publicly before the deal -
called CGCMT 2013-375P - was even launched or priced, causing a
media feeding frenzy that irked many in the market, not least
the issuer and the rival rating agencies, Moody's and Kroll.
While this type of rating agency sniping has been going on
over the past two years for nearly every structured finance
asset class, it has never been timed in this way, according to
Still, many investors believed Fitch had made a valid point:
CMBS risk is ramping up again.
"The underwriters clearly emptied the old bag of tricks on
this one, as far as crisis-era underwriting goes, and the
agencies [fell for] them," said the head of CMBS investing at
one of the biggest asset managers in the country.
"Those tricks included re-measuring the building, lowering
management fees in order to minimize projected expenses, and
creating an 'optimizing' structure that pushes as much away from
the mezzanine debt into the securitization at the Triple B minus
They optimized the total securitization proceeds, and there
are huge economics to be gained from that. The huge beneficiary
is the borrower, who gets something like a 3.5% coupon," said
PRO FORMA LEVERAGE RETURNS
Fitch said this past Monday that the new large loan CMBS
linked to the "prestigious" Seagram Building on Park Avenue was
based on so-called pro forma income and had insufficient credit
enhancement to warrant a Triple A rating. It would only have
rated the senior tranche Single A.
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
By issuing its one-page critique, Fitch, which was
ultimately not hired to rate the deal, brought attention to the
problem of ratings shopping just as the SEC, many members of
Congress, and more than 25 panelists were set to discuss the
very same topic as well as the future of the rating agency
"issuer pays" model for the entire next day in the nation's
But despite the fact that many investors agreed with Fitch's
sentiments and concerns about the notably increased leverage in
the controversial deal, the Triple A portion of the US$572.9m
transaction was increased at pricing on Thursday from US$75m to
US$209m. Spreads on the most subordinate pieces widened
considerably, however. The deal was originally US$439.75m.
Each subordinated tranche had split ratings from Kroll and
Moody's, with the former agency refusing to rate the most
subordinated Class E slice.
The Class A tranche, rated AAA/Aaa (Kroll/Moody's), priced
on the wide side of guidance at swaps plus 92bp; Class B, rated
A-/Aa3, priced as expected at plus 135bp; Class C, rated
BBB-/A3, widened to plus 175bp from initial price guidance of
plus 170bp; Class D, rated BB/Baa3, widened the most to plus
245bp from talk of plus 215bp; and Class E, which Moody's rated
at Ba3, widened to plus 310bp from guidance of plus 300bp. The
lead underwriters were Citigroup and Deutsche Bank.
The underwriters securitized the entirety of the so-called
subordinate, or junior, portion of a US$782.75m commercial
mortgage on the Seagram building.
However, they only securitized part of the senior portion,
known as the A loan, leaving the flexibility to increase the
Triple A piece in the bond transaction. The remaining
unsecuritized portion of the A loan will be put into an upcoming
multi-borrower CMBS conduit.
There's no doubt that the Seagram Building deal portends a
return to 2007 leverage and raises red flags, multiple CMBS
However, some investors theorized that the buyside viewed
the total debt as aggressive but could live with the leverage.
"I think investors generally think favorably enough of the
asset's intrinsic ability to add value to look through, perhaps,
even stretched future cashflow assumptions, which is something
of a symptom of the rate-repressed world we are obligated to
operate in currently," said Christopher Sullivan, chief
investment officer of the United Nations Federal Credit Union.
"While we don't look at single asset deals like this, I
would guess that Triple A investors thought highly of the
property," added Marc Peterson, a senior CMBS portfolio manager
at Principal Global Investors.
"Moreover, all of the numbers are right there to look at, so
investors can figure it out for themselves."
Moody's and Kroll told IFR, however, that even they
generally thought that the issuer's initial projected numbers
regarding net operating income, occupancy, expenses, structure,
and other metrics on the top-notch building were way too
Therefore, each agency assumed a steep haircut on the
building's net cashflow and valuation in order to arrive at its
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 Tad Philipp, director of
commercial real estate research at Moody's.
"Investors are well protected, from a credit standpoint,"
"This building is in the top three in New York," said
Philipp. "It can attract tenants and capital. Even during a
crisis, opportunity funds and others will line up to buy there."
Others in the market also said that Fitch was being
hypocritical, conveniently picking and choosing which deals to
make a stink about in a bid to get attention.
In January, Fitch rated a CMBS titled GSMS 2013-KYO, linked
to six hotels in Honolulu, which was said to have used pro forma
underwriting; similarly, last November Fitch gave Triple A
grades to a deal linked to an office building, 1290 Ave of the
Americas, with pro forma projections.
In response, the head of CMBS at Fitch, Huxley Somerville,
said that Fitch used a highly stressed cashflow assumption on
the deal backed by the Kyo-Ya hotel portfolio.
The underwriter, Goldman Sachs, used pro forma assumptions
to calculate so-called Revenue Per Available Room (RevPAR),
presenting a projected cashflow of US$174.4m. However, Fitch
assumed a much lower cashflow at US$145.4m, Somerville said.
Similarly, on the deal backed by a loan on 1290 Ave. of the
Americas in Manhattan, Somerville said there was a US$10m
leasing reserve to cover future leasing costs; the underwriter's
cashflow was US$94.4m, while Fitch assumed US$89.9m.
This past week's bickering, while not directly mentioned at
the SEC roundtable, added fuel to the fire in the media as US
senators urged regulators to make long-awaited changes to the
"issuer pays" model which many blame for the shoddy ratings that
led to the financial crisis.
Nearly three years after Dodd-Frank, Washington has still
not come up with a viable alternative to the controversial
Senator Al Franken was still pushing for his "Franken
amendment", which would create an independent government board
that chooses which agency rates each structured deal, but
panelists from the Big Three agencies (S&P, Moody's, and Fitch)
said that such a system would create conflicts of its own.
(A version of this story will appear in the May 18 issue of
International Financing Review, a Thomson Reuters publication;
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