S&P Said to Face SEC Probe on 2011 Commercial-Mortgage Bond

Photographer: Michael Nagle/Bloomberg

Standard & Poor's signage is displayed outside of the company's building in New York. Close

Standard & Poor's signage is displayed outside of the company's building in New York.

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Photographer: Michael Nagle/Bloomberg

Standard & Poor's signage is displayed outside of the company's building in New York.

Standard & Poor’s is facing scrutiny from the U.S. Securities and Exchange Commission for how it rated a commercial-mortgage bond in 2011, three people with knowledge of the matter said.

The inquiry extends beyond the securities and period that are the subject of a lawsuit brought in February by the U.S. Justice Department against New York-based McGraw Hill Financial Inc. (MHFI) and its S&P unit, according to two of the people, who asked not to be identified without authorization to speak publicly. Massachusetts has also looked into S&P’s post-crisis methods, Bloomberg News reported Feb. 21.

“We reviewed the application of our CMBS methodology and determined that the approach used for new transactions rated in 2011 produced results that were consistent with Standard & Poor’s rating definitions and resulted in no ratings changes,” Ed Sweeney, an S&P spokesman, said in an e-mailed statement.

John Nester, an SEC spokesman in Washington, declined to comment on whether the agency was scrutinizing the deal, as reported earlier today by Dow Jones Newswires.

In July 2011, S&P pulled assigned grades on a $1.5 billion offering from Goldman Sachs Group Inc. and Citigroup Inc., prompting the banks to abandon the deal after it was placed with investors. S&P yanked the rankings after discovering potential discrepancies in how its methodology was being applied, the company said at the time.

CMBS Halt

The credit rater then halted rating any new commercial-mortgage bonds, saying it had to review a potential discrepancy in its model. That August, the company said the conflict had turned out not to be significant and it would resume grading deals.

The disruption kept S&P, the world’s biggest credit rater, out of the commercial-mortgage backed securities market for more than a year. The company revised its criteria in September and reentered the market later that month, awarding investment-grade ratings on a $1.5 billion offering from JPMorgan Chase & Co. Moody’s Investors Service, the second-largest credit rater, criticized its competitor, saying the underlying loans in the securities did not “merit” the ranking.

‘Inherent Conflict’

U.S. lawmakers targeted the credit-grading business as part of the 2010 Dodd-Frank Act after the collapse of top-ranked mortgage-backed securities helped spark the longest recession since the 1930s. The legislation removed some rating references from regulation without changing the model of issuers paying the companies to grade their bonds.

“The inherent conflict of interest in the issuer-pay system hasn’t been resolved in any way, shape or form,” Jeffrey Manns, an associate professor of law at George Washington University, said in a telephone interview.

Grading securities tied to debt on skyscrapers, hotels and shopping centers is one of the most lucrative businesses for ratings companies. The firms generally charge $1 million to $2 million to grade a commercial-mortgage bond, which bundles the loans into securities of varying risk, according to an October 2011 paper by Andrew Cohen, a researcher at the Federal Reserve.

The Justice Department sued S&P Feb. 4 in federal court in Los Angeles, accusing the company of inflating grades to win business on bonds backed by home loans made to the riskiest borrowers from September 2004 to October 2007. The U.S. is seeking more than $5 billion in damages, or more than five years of profit.

S&P denies the allegations and said in a Feb. 5 statement it will defend itself “vigorously.”

To contact the reporter on this story: Matt Robinson in New York at mrobinson55@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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