S&P Quits Grading Most CDOs That Investor Said It Underrated

Standard & Poor’s withdrew most of its ratings on a type of security built from bank debt, two months after an investor sought a court order to require more “accurate” grades.

The withdrawals “reflect the additional effort required to surveil these transactions” and a “view that there is limited market interest in maintaining the ratings,” the McGraw Hill Financial Inc. unit said in a statement Tuesday. It said its move affected grades on 76 trust preferred collateralized debt obligations.

Brett Jefferson, whose hedge fund firm Hildene Capital Management LLC invests in the securities, said he accused S&P of grading the debt too conservatively and of collecting fees that it did "nothing to earn,” in a letter to the company dated Oct. 2.

“We welcome as a positive step S&P’s action today to withdraw from issuing ratings on numerous tranches,” he said in an e-mail on Tuesday. S&P “was not devoting adequate resources to issue reliable ratings to market participants.”

John Piecuch, a spokesman for S&P, declined to comment beyond the announcement.

‘Ludicrous’ Methodology

By Hildene’s calculations, S&P’s ratings for the TruPS CDOs implied that about 80 percent of banks in the U.S. will fail over the next 20 years. S&P’s rating methodology is “ludicrous,” Hildene has said in about a dozen letters to the bond grader since 2010, according to Jefferson.

CDOs take fixed-income assets, such as bonds or loans, and bundle them into new securities of varying risk. There were almost $60 billion of TruPs-backed CDOs issued from 2000 to 2007, before the financial crisis froze the market for new issues.

S&P raised ratings on parts of 10 of the CDOs on Tuesday before withdrawing its grades. One tranche of a deal called ALESCO Preferred Funding III was lifted by S&P to BB from CCC before the grades were removed.

Moody’s Investors Service and Fitch Ratings hold that bond at Aa1 and BBB, respectively.

“The discrepancy in ratings between these grades is enormous,” said Sylvain Raynes, founder of R&R Consulting, which specializes in structured finance and credit ratings.

“In going from Aa1 to CCC, the difference in their associated default probabilities is in the range of 15,000 times,” he said. “It’s like the difference between the credit strengths of Switzerland and Zimbabwe. They are on different solar systems.”

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