The LTVs of collateral pools as determined by the issuers an

The LTVs of collateral pools, as determined by the issuers and the rating agencies, are always very different. The primary reason for this difference is that

a) Rating agencies apply capitalization rates taking into account the impact of debt leverage on the property.

b) Rating agencies use ‘Stressed’ or ‘Stabilized’ cap rates which are more conservative than market capitalization rates in effect at the time the pooled loans are securitized.

c) Issuer capitalization rates include forward rate projections.

d) None of the above.

Solution

Answer: Rating agencies use ‘Stressed’ or ‘Stabilized’ cap rates which are more conservative than market capitalization rates in effect at the time the pooled loans are securitized.

Reason: The issuers are more biased and would like their securitized product to sell and hence give aggressive capitalization rates. However, the rating agencies are free from any biases and in order to prevent a major financial crisis, they use conservative capitalization rates.