The charges being leveled against Standard & Poor’s ratings criteria for commercial-mortgage backed securities this morning brings to mind memories of the false comforts during the latest housing boom.
That’s right, those cozy moments in 2005 when bond investors thought everything was going great — after all, they had these triple-A ratings telling them so.
We know how that story ended, or rather unfolded, as we still feel the sting of those poor decisions made by the credit ratings agency, even today.
And so enters the Securities and Exchange Commission with this gem:
"SEC announces charges against Standard & Poor’s for fraudulent ratings misconduct"
Ladies and gentlemen, it’s been some time since the mortgage bond world felt shaken to the core. But shaken, right now, it feels, according to several conversations I’ve had on the subject this morning.
“They lied,” one source told me about the SEC charge that S&P “published a false and misleading article purporting to show that its new credit enhancement levels [for CMBS ratings] could withstand Great Depression-era levels of economic stress."
As a result, the SEC banned S&P from rating similar deals for a year. S&P agreed to pay more than $58 million to settle the SEC’s charges, plus an additional fines to three attorneys general. The fines cover the false ratings of six conduit fusion CMBS transactions in 2011.
“The question remains, did they also do this for residential mortgage bonds?” the source asked.
The answer, sadly, is probably yes.
And, these residential mortgage bond deals fit squarely in the bailiwick of HousingWire:
"A third SEC order issued in this case involved internal controls failures in S&P’s surveillance of residential mortgage-backed securities ratings. The order finds that S&P allowed breakdowns in the way it conducted ratings surveillance of previously-rated RMBS from October 2012 to June 2014.
S&P changed an important assumption in a way that made S&P’s ratings less conservative, and was inconsistent with the specific assumptions set forth in S&P’s published criteria describing its ratings methodology.
S&P did not follow its internal policies for making changes to its surveillance criteria and instead applied ad hoc workarounds that were not fully disclosed to investors."
S&P claims the inaccurate descriptions are being corrected and publicly retracted the false and misleading information.
S&P neither admits nor denies the claims, of course, and for once I think that is a bad call.
My reporters covered these deals, and also trusted in S&P’s ratings criteria.
It may be awhile before that trust gets restored.
So what’s the impact on the market? It’s good and bad.
This is from a Barclays note to clients this morning:
"In the conduit space, S&P only rated 5.6% of the market in 2014, and all of these bonds were also rated by either Fitch or Moody’s. With the small market share, the new issue market is likely to be unaffected by the loss of S&P in 2015."
Whew. The impact on the market is thankfully muted.
Wait. The bonds were also rated by Fitch and Moody’s. If those two credit ratings agencies also awarded the bonds similar ratings, then what does that say about the ratings criteria of all Nationally Recognized Statistical Rating Organizations?
Presumably, the ratings were similar and did not raise any alarm bells. It wasn't until the author of the S&P CMBS report complained to the SEC that the work was being used as a "sales pitch" to drum up more CMBS business for S&P that anyone stopped to take note.
That's what is completly and utterly shocking about this morning's announcement.
Today's news highlights that we must continue to take ratings for what they are: a supplemental risk-measurement tool — not a replacement for internal investor due diligence.