01/20/2012

S&P Falls Further Back in CMBS Ratings

S&P faces a long slog as it tries to rebuild its commercial MBS rating business, after falling to last place among agencies that rated the most common type of offerings last year.

Once the perennial market leader, S&P is widely expected to win back the support of issuers and investors eventually. But its slide allowed Moody’s and Fitch to cement their dominant positions in CMBS ratings last year, according to Commercial Mortgage Alert’s CMBS Database (see ranking on Page 10). Meanwhile, upstarts Morningstar, DBRS and Kroll made inroads that could prove long-lasting.

“What this shows is the receptivity in the market to other voices,” said Eric Thompson, CMBS chief for Kroll, the market’s newest player. “A year ago, we were hopeful of that. But these figures are proof.”

Before the market collapsed, S&P routinely rated the largest annual volume of conduit/fusion offerings, which make up the lion’s share of issuance. But after slipping to third place in 2010, S&P tumbled to fifth last year. It graded just $4.5 billion of conduit deals for an 18% market share, down from 82-88% in the pre-crash years. That effectively resulted in a last-place finish. (Kroll technically placed last in that league table because it rated $249.3 million of “rake” classes tied to one loan in a multi-borrower deal.)

Moody’s jumped ahead of Fitch in the conduit ranking, after the two finished 2010 in a virtual tie amid much-lower volume. Moody’s rated $20.3 billion, or 82%, of multi-borrower transactions in 2011, while Fitch racked up $18.8 billion of assignments (76%). In 2010, both agencies handled $4.3 billion of issues. Morningstar jumped two notches to third place in the conduit sector last year, with $6.3 billion of deals for a 26% market share (up from 6% in 2010). DBRS held onto fourth place at $5.7 billion, or 23% (up from 15%).

S&P’s loss of market dominance stems partly from its controversial decision to overhaul its CMBS ratings criteria in 2009. The intent was to appeal to investors by taking a tougher stance on credit quality. But the result was a huge swath of downgrades of legacy CMBS — some of which were upgraded again shortly after — burning many buysiders and leaving them distrustful of the agency’s methodology.

Complaints reached a fever pitch in late July, when S&P abruptly withdrew its ratings after the pricing of a $1.5 billion multi-borrower transaction. That caused the deal to be scuttled on the eve of settlement, costing the issuers millions and hurting some investors as well. Since then, issuers have bypassed S&P on fixed-rate deals backed by loans to multiple borrowers.

Buysiders and issuers alike expect S&P to return, gradually, to a major role in CMBS ratings, provided it establishes a track record of clear and consistent ratings.

“As long as they figure out what they’re going to do, everything should be fine,” said a CMBS portfolio manager at a real estate fund shop. “I would think by mid-2012, people will get past it.”

An executive in a similar post at a major insurer added, “I have no quarrel with them. I won’t tell an issuer not to hire them. But I know some people have a grudge against them.”

Many institutional CMBS buyers have internal purchasing guidelines that require ratings from one or two of the traditional top three agencies, which market players said will help keep S&P in the game. The upstart agencies have been trying to persuade investors to change that institutional bias, contending they offer superior services.

For example, Morningstar points out that it re-underwrites all loans to be securitized, while other agencies only do that for some. “We act as if we’re the B-piece buyer on the transaction. That’s how much detail we’re giving,” said Robert Dobilas, president of Morningstar’s structured-credit rating business.

DBRS, meanwhile, has just started releasing monthly surveillance reports on a deal-by-deal basis that are designed to provide bondholders with additional insights into analysts’ interpretations of servicing data. The agency’s CMBS chiefs are Mary Jane Potthoff and Erin Stafford.

Kroll incorporated an open letter to pension-fund managers in its recent advertising, urging them to include all SEC-approved rating agencies in their investment guidelines. In that letter, chief executive Jules Kroll contended that less than 20% of top pension funds currently allow this. Kroll, which entered the CMBS business a year ago, so far has rated three single-borrower deals, a large-loan floater and a seasoned-loan deal. It expects to unveil initial rating criteria for conduit deals by early March.

S&P rated 87% of total CMBS issuance in the U.S. during the boom years of 2005-2007, while Moody’s covered 76% and Fitch graded 63%. DBRS was their only challenger in the new-issue market during that stretch, with a market share of just 5%.

Last year, S&P dropped to fourth place in the overall U.S. ranking. Its market share plunged by more than half to 24% from 57% in 2010, when it held second place. Moody’s continued to lead the pack by rating 77% of last year’s U.S. deals. Fitch moved up one notch to second place with a 71% share. And Morningstar jumped two notches to the No. 3 spot, with 26%.

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