$8.4 Billion in CMBS B-Piece ‘Repacks’ Face Downgrades

It’s official: the credit crunch is moving into the commercial real estate market.

Fitch Ratings said Wednesday night that it had put $8.4 billion of CBMS B-piece resecuritizations under negative ratings watch, the result of updating its ratings methodology for so-called ‘repacks.’

CMBS B-piece resecuritizations (also referred to as first loss CDOs and/or ReREMICs) are commercial real estate CDOs and ReREMIC transactions that include the most junior bonds of CMBS transactions.

A stunning $3.2 billion of the potential downgrades in these deals represent tranches which are currently rated ‘AAA’ by Fitch; $1.2 billion are currently rated ‘AA.’ According to Fitch, these transactions generally hold over 50 percent of non-rated first loss and ‘B’ category or below-rated CMBS bonds.

“Recent headline defaults such as Centro and MBS support Fitch’s prediction for CMBS defaults at least doubling in 2008,” said Susan Merrick, head of Fitch’s U.S. CMBS group.

“While investment grade rated CMBS bonds would remain insulated based on current credit enhancements, the below investment grade classes, generally those contributed to these CDOs/ReREMICs, would be impacted.”

From the press statement, an admission that original rating assumptions might have been more than a tad too optimistic:

… the revised methodology generally assumes a 100% loss on any non-rated first loss bond for any rating stress above a ‘B’. As assets achieve significant seasoning, they are afforded some graduated benefit to higher rating stresses. Similarly, underlying CMBS assets in the ‘CCC’ and ‘B’ category are also modeled to experience significant loss severities upon a default. In addition, higher penalties have been assigned to account for a transaction’s concentration within a single industry (CMBS). Based on these changes to the methodology, it is expected that many of the rated liabilities within these transactions will experience multiple notch downgrades.

In other words, Fitch has figured out that what’s true in residential-backed derivatives is also true in commercial-backed derivatives — slicing up a pool a B-piece bonds doesn’t change the fact that the underlying assets are still B-piece bonds.

Fitch said it would complete its review in 90 days; I’d expect plenty of downgrades to begin hitting these securities, as a result.