Is this the end of CMBS 2.0 or just a few careers on Wall Street?

On July 27, Standard & Poor's withdrew the ratings it had given to a $1.5 billion commercial mortgage offering from Goldman Sachs Group Inc. and Citigroup Inc that was set to close the next day, forcing Goldman and Citi to pull that commercial mortgage bond offering, already placed with investors, after the close of business July 28th.

Those immediately impacted by the collapse of this transaction are the bookrunners, dealers and investors on the deal who all incurred various types of expenses, including legal and due diligence costs, as well as hedging costs since the bonds were effectively sold last Friday.  Any transactions on these bonds in the secondary market would have to be unwound as well.  Goldman and City now have a major loan pool to carry on their books longer than anticipated whose fate must be determined in a significantly weaker market.  Their customers did not get the bonds they anticipated.  S&P has suffered reputational damage.

In any other week, this would qualify as major financial news on many levels, as the parties affected by this decision are not just the participants in that particular securitization.  But with all the anxiety provoked by failure to resolve the debt ceiling issue, the European debt crisis and a generally uncertain economic outlook, the impact on CMBS 2.0 is heightened.  The larger CMBS marketplace was already concerned about potential erosion in investor and issuer confidence.  The nascent CMBS 2.0 market was wobbly from the anticipated impact of Dodd-Frank and perceived looser quality standards in credit underwriting of recent loans.  Spreads were widening on the newer deals.  Losing S&P, one of the two major rating agencies, potentially damages the credibility of the market.  CMBS originations are likely to stall in the near future while all this gets sorted out.

In announcing its withdrawal from rating CMBS conduit/fusion (multi-borrower) transactions, S&P stated that it discovered two different methods of calculating debt service coverage ratios were being used internally by two groups at S&P beginning in early 2011.  In its review of the older deals, the surveillance group at S&P relied on the worse of (i) actual debt service amounts and (ii) stressed ratios.  In the newer deals, the S&P new ratings group used a simple average of the two methods.  S&P is conducting an internal review to see if this impacts any outstanding ratings.  

A contrarian view of this debacle is that S&P's absence could increase the flexibility of the remaining rating agencies in their requirements for subordination levels on CMBS deals, as S&P consistently demanded higher subordination levels on these new deals.  Additionally, Moody's stands to benefit as it is the other one of the two key agencies whose imprimatur is required on CMBS deals.  

Whatever the ultimate fallout, this has made for an interesting week's end for all in the CMBS 2.0 world.