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S&P Blocked in CMBS After Derailed Goldman Sachs Deal: Mortgages

Standard & Poor’s is frozen out of the commercial-mortgage bond market by the biggest underwriters after derailing a $1.5 billion sale by Goldman Sachs Group Inc. (GS) and Citigroup Inc. last July.

Since then, those banks along with JPMorgan Chase & Co. (JPM), Deutsche Bank AG and Morgan Stanley have bypassed S&P’s credit ratings as they issued $11.3 billion of debt linked to skyscrapers, shopping malls and hotels, according to data compiled by Bloomberg. They’re turning to Kroll Bond Ratings Inc. and Morningstar Inc. (MORN) after S&P, the world’s largest credit- rating company, forced bankers to pull an offering they’d already committed to sell, roiling the $600 billion market.

“S&P no doubt suffered an extraordinary loss of credibility in this area that will take time and some restructuring to repair,” said Chris Sullivan, who oversees $1.9 billion as chief investment officer at United Nations Federal Credit Union. “It utterly surprised people.”

Wall Street banks and investors are demonstrating the possibility of competition in the ratings business, even as regulators struggle to break S&P, Moody’s Investors Service and Fitch Ratings’ stranglehold on other bond markets. Four years after the three firms were blamed by regulators for fueling the financial bubble by inflating their grades for toxic mortgage securities, they provide 97 percent of all credit ratings, the Securities and Exchange Commission said in a September report.

‘Ultimate Success’

Ed Sweeney, a spokesman for S&P, said the New York-based company’s CMBS analysts weren’t available to discuss the situation. “We believe our ultimate success will be based on the value investors derive from the ratings and research,” he said in an e-mail.

Ranking structured products such as CMBS and collateralized debt obligations is one of the most lucrative areas for rating firms. They generally charge between $1 million and $2 million to grade a CMBS deal, which are bundled loans tied to commercial properties sliced into securities of varying risk, according to a September paper by Andrew Cohen, a researcher at the Federal Reserve.

The lack of an S&P rating isn’t hurting issuers. Deutsche Bank priced the safest portion of a CMBS deal last week ranked AAA by Fitch and Moody’s to yield 110 basis points, or 1.1 percentage points, more than the benchmark swap rate, the tightest spread since May. Banks are forecasting as much as $45 billion of sales this year, up from $28 billion in 2011.

About one-third of investors polled in a Deutsche Bank survey said they preferred deals without an S&P ranking, the Frankfurt-based lender said in a Feb. 27 report. About 15 percent said they look forward to those rated by the new entrants. More than half said the rating companies didn’t play a role in their investment decisions.

Pulled Ratings

S&P (MHP)’s decision to pull its ratings on the $1.5 billion offering in July interrupted the market’s recovery after issuance seized up in 2008. A record $232.5 billion was sold in 2007 before losses on home-loan securities froze credit markets.

S&P withdrew rankings on the deal on July 27 and temporarily stopped rating new commercial-mortgage bonds, saying it had to review a potential conflict in its model. The following month, it said it would resume grading deals and that the conflict had turned out not to be significant.

The banks were forced to cancel the transaction five days after it was placed with investors. Goldman Sachs reimbursed buyers for losses they incurred when the deal was withdrawn, people familiar with the transaction said at the time.

Morgan Stanley analyst Richard Parkus called the event “unprecedented,” and said that it “severely eroded” investor and issuer confidence in S&P’s ratings.

Charlie Brown’s Football

“You look to rating companies for predictability and a degree of certainty,” said Patrick Sargent, a partner at law firm Andrews Kurth LLP in Dallas. “It was like Lucy pulling the ball away from Charlie Brown.”

This wasn’t the first time S&P riled investors and banks in the CMBS market. It downgraded dozens of top-ranked bonds in 2009, excluding them from the Federal Reserve’s $1 trillion Term Asset-Backed Securities Loan Facility designed to cleanse bank balance sheets and jumpstart lending. They backtracked on some of the securities a week after reducing them to BBB-, the lowest investment-grade ranking, saying there had been an adjustment on the assumptions on the timing of losses on the mortgages.

‘Inconsistent Approach’

Investors still hold a grudge, according to Darrell Wheeler, a commercial-mortgage debt strategist at Amherst Securities Group LP.

“Given their inconsistent approach to ratings and an unreceptive investor audience, it is difficult to see the upside for an issuer including S&P in a deal,” Wheeler said.

Two weeks after S&P antagonized CMBS bankers, it downgraded the U.S., setting off a stock-market swoon and drawing criticism from President Barack Obama. Treasury yields then fell to record lows. The company later sent, then retracted, an erroneous message suggesting France had been downgraded. The backlash may have prompted parent company McGraw-Hill Cos.’s decision to replace the unit’s top executive, according to Peter Appert, an analyst at Piper Jaffray & Co.

“You’ve had a series of miscues,” Appert, who’s based in San Francisco, said in a telephone interview. “Under their new leadership, they’re taking some significant and proactive steps to address these issues.”

McGraw-Hill fell 0.5 percent to $46.15 at 9:44 a.m. in New York. It’s up about 3 percent this year.

New President

S&P announced it had hired Douglas Peterson, a former Citigroup executive, as president, in August, and in December, he replaced David Jacob, head of structured finance, and reassigned Mark Adelson, chief credit officer, to a research role with less responsibility. The two had been involved in the decision to withdraw the CMBS ratings, according to three people familiar with the matter, who declined to be identified because the deliberations were private. Barbara Duka, who was in charge of CMBS ratings at the time of the July deal, was removed from her position this year, one of the people said.

Wall Street has issued 10 so-called CMBS conduit deals since the review, none of which have been ranked by S&P. The firm’s market share plummeted to 26 percent of last year’s deals from 43 percent in 2010, according to Commercial Mortgage Alert, a newsletter. Morningstar picked up some of the business, rating 30 percent of deals, while Kroll evaluated 14 percent. Goldman Sachs and Citigroup resuscitated the pulled deal in September with ratings from Moody’s, Fitch and Morningstar.

“We didn’t think we would get on as many transactions as we did last year,” Eric Thompson, Kroll’s head of CMBS in New York, said in a telephone interview in February. “We view it as an indicator of folks in the marketplace looking for a fresh voice.”

To contact the reporters on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net; Zeke Faux in New York at zfaux@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Rob Urban at robprag@bloomberg.net

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