CMBS Rating Methodology

DBRS has today released its updated CMBS rating methodology and modeling approach for large pooled transactions.

DBRS refines its model and updates its stress parameters continuously. While the effect of this revision is neutral for the vast majority of existing CMBS transactions, it incorporates substantial and important refinements which allow DBRS to take a more nuanced view of the loan collateral, and better assess the risk that each loan faces. DBRS rates through the cycle and the refined modeling approach continues to take into consideration each loan’s exit strategy, the possibility of severe cash flow stress, as well as any potential rises in the cost of capital.

The CMBS rating methodology has not changed; a stabilized loan-level net cash flow remains at the crux of the analysis. However, other elements of the model underwent a substantive transformation. We found it necessary to abandon some well known metrics such as loan-to-value (LTV) and replace them with leverage benchmarks that prove to be more durable throughout the economic cycle.

We also incorporated a more refined stress of the cost of capital. A stress which incorporates current market forward rates, rate spread expectations, and considers the potential volatility of these as they relate to each individual loan at each rating category.

We took a more in-depth look at concentration and diversity, and addressed the reality of increasing concentration risk as transactions season.

In this publication, DBRS lays out its revised CMBS rating methodology and the asset-specific analytical procedures to which we adhere.

Real estate assets were traditionally viewed as a source of stable cash flow and a long-term hedge against inflation. Heading into 2010, it is important to be reflective on what has occurred in the real estate market. Delinquencies in CMBS have reached historical levels as real estate values and cash flows have declined, as a result of the economic recession and a period of illiquidity. The entire market is working through a period of delevering and the commercial real estate market must do the same. As the CMBS market works through the delinquencies, DBRS anticipates the structures will be tested and the new structures will emerge. DBRS will continue to update its methodology to best capture the metrics that indicate performance through the economic cycle.

We encourage and look forward to answering any questions one might have regarding the CMBS methodology and the large diverse pool model.