As an immediate consequence of Standard & Poor’s recent downgrade of the U.S. sovereign longterm debt rating from AAA to AA+, the defeasance industry was almost brought to a standstill as the U.S treasuries that are typically utilized as collateral in defeasances transactions no longer met S&P’s defeasance guidelines. In addition, as a result of the downgrade, S&P needed to review its ratings assigned to U.S. CMBS transactions that include defeased loans.
On August 16, 2011, Standard & Poor’s updated its defeasance criteria for U.S. CMBS transactions by deleting its requirement that securities used as the substitute collateral for a commercial mortgage in a defeasance portfolio must be rated AAA by Standard & Poor’s. The balance of the criteria, published in 2003 and still in effect, provided that securities in a defeasance portfolio, among other things, should:
- constitute “government securities” as defined in Section 2(a)(16) of the Investment Company Act of 1940, as amended (15 U.S.C. 80a-1);
- have a principal amount due at maturity that cannot vary or change;
- provide for interest at a fixed rate; and
- not be subject to prepayment, call or early redemption.
The August 16 update also states that the rating assigned to a U.S. CMBS transaction that is fully defeased will be no higher than the credit quality of the defeased collateral. However, the rating assigned to a U.S. CMBS transaction that is only partially defeased (e.g., the collateral is a combination of government securities and commercial real estate mortgages) will be based on Standard & Poor’s assessment of the credit quality of all remaining collateral, as well as specific transaction details relevant to its credit rating. One consequence of this update is that now a defeasance of a CMBS loan can potentially negatively impact the rating of the pool in which it is securitized. Standard & Poor’s will need to perform its credit analysis with regard to this issue as part of its process of reviewing a request for a defeasance on an individual loan.