Wall Street banks including Morgan Stanley and Deutsche Bank AG slammed Standard & Poor’s decision to suspend ratings on commercial-mortgage bonds after finding a flaw in the review process.
S&P withdrew rankings it had assigned to a $1.5 billion offering from Goldman Sachs Group Inc. and Citigroup Inc., forcing the banks to scuttle the deal after it was placed with investors. It then yanked ratings on Freddie Mac’s $1.19 billion deal that JPMorgan Chase & Co. and Wells Fargo & Co. sold earlier this month that has yet to be completed.
“The manner in which S&P took its action has severely eroded investor and issuer confidence in its ratings,” Morgan Stanley analysts led by Richard Parkus in New York wrote in a note yesterday, referring to the Goldman Sachs and Citigroup transaction. “Such an event is unprecedented within the CMBS market.”
S&P’s decision is impeding bank efforts to unload mortgages they have accumulated for sale as securities and introduces new risks for debt tied to hotels, shopping centers and offices. The $700 billion market was already showing signs of strain as investors pushed back against new sales amid sovereign crises and looser underwriting standards.
“At this point, many may lose confidence in CMBS 2.0 and given everything else going on, it could not have come on a worse week,” Deutsche Bank analysts Harris Trifon and Dave Zhou, based in New York, wrote in a report titled “S&P downgrades itself and sinks GC4,” referring to the first withdrawn deal.
S&P is reviewing the application of its criteria for offerings that pool multiple commercial mortgages, the firm said in a separate statement. “The review was prompted by the discovery of potentially conflicting methods of calculation,” of how income from the properties relates to their debt burden.
Ed Sweeney, an S&P spokesman, said the firm had no further comment.
“Ratings are a condition precedent to closing and settlement,” Goldman Sachs and Citigroup said yesterday in a joint statement. S&P “had previously informed Goldman and Citi that they were prepared to rate” the transaction, they said.
The deal was also graded by Morningstar Inc., which was prepared to rank the offering, said Joe Petro, a managing director at the Chicago-based firm. Petro said he fielded several calls from frustrated investors yesterday.
“Nobody can really understand why S&P’s doing what they’re doing,” Petro said. “We stand by the analysis that we put out on the transaction.”
Goldman Sachs and Citigroup overhauled the offering last week to increase the amount of protection the AAA portion of the deal had against losses, after investors questioned the level. They priced the deal after increasing relative yields on the BBB bonds by 200 basis points to 700 basis points more than benchmark swap rates on the offering.
JPMorgan and Wells Fargo placed the commercial-mortgage bonds for the Freddie Mac deal with investors earlier this month, according to a person familiar with the transaction, who declined to be identified because terms aren’t public. The deal was supposed to settle on Aug. 10, the person said.
S&P withdrew the preliminary ratings because of the review process, the ratings company said in a July 28 statement. The deal was also ranked by Fitch Ratings.
The confusion may lead to a pull-back in originations in the near-term, according to James Grady, a managing director at Deutsche Asset Management in New York, which manages $240 billion, including commercial-mortgage debt.
“CMBS origination platforms have enough risk in their business model, from spread volatility to the risk that investors reject individual loans,” said Grady. “They don’t need to deal with a complete wild card like this.”
More than $22 billion of commercial-mortgage bonds have been sold this year, compared with $11.5 billion in all of 2010, according to data compiled by Bloomberg.
Sales of the debt peaked at $234 billion in 2007, helping fuel a boom in property prices. Issuance plummeted to $12.2 billion in 2008 as souring subprime-home loans infected credit markets. The market stayed closed until November 2009, choking off funding to borrowers with debt coming due.
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