S&P Revising Commercial Mortgage Ratings After Freeze-Out

Standard & Poor's
Standard & Poor's plans to change the way it rates the securities. Photographer: Michael Nagle/Bloomberg

Standard & Poor’s, the ratings firm frozen out of the commercial-mortgage bond market since last year, plans to change the way it rates the securities.

The changes may trigger downgrades for about 15 percent of bonds that S&P rates and upgrades for 10 percent, the unit of New York-based McGraw-Hill Cos. said today in a statement. Securities will start requiring a “credit-enhancement level” that protects bonds from the first 20 percent of losses to receive top AAA ratings, it said. The firm said it will accept comments on the proposal until July 2.

Wall Street banks have been bypassing S&P’s ratings since the firm derailed a $1.5 billion sale by Goldman Sachs Group Inc. and Citigroup Inc. in July by pulling its grades on the securities. Since then, S&P hasn’t rated a so-called conduit deal, the biggest part of the market, according to data compiled by Bloomberg.

“The results should provide the market with more stable ratings and better differentiation of relative credit risk,” Gary Carrington, S&P’s global criteria officer for CMBS, said in the statement.

The proposed changes may lead to AAA portions of deals issued as recently as May 2011 losing the top grades, Richard Hill, a debt analyst at Royal Bank of Scotland Group Plc, said in a telephone interview today.

Most Lucrative

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

“A revision to its prior method was essential to any attempt to revitalize its structured-finance practice,” Chris Sullivan, who oversees about $1.9 billion as chief investment officer at United Nations Federal Credit Union in New York, said in an e-mail. “Any successful repair to S&P’s damaged credibility in this market will only be realized over time.”

S&P withdrew rankings on the deal arranged by Goldman Sachs and Citigroup 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 the conflict had turned out not to be significant and that it would resume grading deals.

S&P Shakeup

The banks were forced to cancel the transaction five days after it was placed with investors, and the pulled rating interrupted a broader recovery in CMBS sales. Goldman Sachs reimbursed buyers for losses they incurred when the deal was withdrawn, people familiar with the transaction said at the time. Wall Street banks have arranged about $8.75 billion of the deals this year without S&P’s rankings.

Carrington was appointed in March in one of a series of personnel changes at the ratings firm since Douglas Peterson took over as president in September. In February, S&P moved Peter Eastham to New York from Melbourne to be head of CMBS ratings, replacing Barbara Duka, who left the firm. Ian Thompson replaced Mark Adelson as the overall chief credit officer in December. David Jacob, who was head of structured finance, left last year.

The new criteria, which S&P had said last year it was planning, would result in upgrades for about 10 percent of so-called “super senior” bonds and downgrades for 5 percent, S&P said.

“The magnitude of the changes contemplated do not appear they will result in substantive changes to outstanding ratings,” Harris Trifon, a commercial-mortgage debt analyst at Deutsche Bank AG and a former employee of S&P, said in an e-mail today. The shift “may result in a small number of changes for legacy super-senior bonds, which represent the linchpin of investor complaints.”

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