The Securities and Exchange Commission has banned Standard & Poor's from rating commercial mortgage bond conduits for one year.
The suspension is part of a settlement with the SEC and the attorney generals of New York and Massachusetts. It relates to over $1.5 billion of commercial mortgage bonds that S&P rated in early 2011.
S&P pulled the ratings a few months later, citing potential problems with its models. This caused market disruption, prompting an investigation by the SEC and the two attorney generals; they discovered that S&P had departed from its published criteria and went with assumptions that were less conservative than advertised.
“Investors rely on credit rating agencies like Standard & Poor’s to play it straight when rating complex securities like CMBS,” Andrew J. Ceresney, director of the SEC’s enforcement division, said in a press release. “But Standard & Poor’s elevated its own financial interests above investors by loosening its rating criteria to obtain business and then obscuring these changes from investors.”
One order, in which S&P made certain admissions, charges S&P with failing to disclose a change in its methodology for calculating debt service coverage ratio in late 2010. This change lowered the amount of credit enhancement necessary to achieve a particular rating for transactions then in the market.
“S&P’s public disclosures affirmatively misrepresented that it was using one approach when it actually used a different methodology in 2011 to rate six conduit fusion CMBS transactions and issue preliminary ratings on two more transactions,” the SEC said in its statement.
As part of its settlement, S&P agreed to stop rating new CMBS backed by geographically diverse pools of at least 20 mortgages made to unrelated borrowers. The rating agency can still engage in surveillance of outstanding conduits that it has previously rated.
Given S&P's small market share, the new issue market is unlikely to be unaffected. In research published today, Barclays noted that S&P rated just 5.6% of the CMBS conduits issued in 2014. And all of these bonds were also rated by either Fitch Ratings or Moody’s Investors Service.
The ban does not apply to bonds backed by a single commercial mortgage or loans to a single borrower, an area of the market where S&P has gained significant market share.
A second order relates to the rating agency's effort to get back into the market in 2012, after it had pulled the faulty ratings. "To illustrate the relative conservatism of its new criteria, S&P published a false and misleading study purporting to show that its new credit enhancement levels could withstand Great Depression-era levels of economic stress," the SEC said.
Without admitting or denying the findings in the order, S&P agreed to publicly retract the misleading marketing and correct the inaccurate descriptions in the publication about its criteria.
A third order finds that S&P allowed breakdowns in the way it conducted surveillance of previously-rated residential mortgage backed securities from October 2012 to June 2014, making its criteria less conservative. Without admitting or denying the findings in the order, S&P agreed to extensive undertakings to enhance and improve its internal controls.
S&P, a unit of publishing house McGraw Hill, will also pay $77 million in fines, including $12 million to New York and $7 million to Massachusetts.
“We are pleased to have concluded these matters,” Catherine Mathis, S&P’s senior vice president for marketing & communications, said in an emailed statement. “We take compliance with regulatory obligations very seriously and continue to make investments in people and technology to strengthen our controls and risk management throughout the organization.”
Although S&P has put the matter to rest, its former head of CMBS, Barbara Duka, is still in the hot seat. The Commission's enforcement division has begun proceedings against Duka, who left the rating agency in 2012, on allegation that she orchestrated the “shift to more issuer-friendly ratings criteria.”
The case against Duka will be scheduled for a public hearing before an SEC administrative law judge for proceedings to determine what, if any, remedial actions are appropriate.