The U.S. Securities and Exchange Commission's potentialsuspension of Standard & Poor's from gradingcommercial-mortgage backed bonds would threaten a practiceregulators have blamed for fueling the credit crisis.

The SEC has been investigating whether the firm bent ratingscriteria to win business in 2011, according to a person withknowledge of the matter, who asked not to be named becausediscussions between the agency and S&P about a possiblesuspension are private. In a practice known as ratings shopping,banks often seek assessments from several credit graders and choosethe ones that give the most favorable views when assemblingasset-backed bond deals linked to everything from auto loans tomortgages.

“Even temporarily taking away a slice of S&P's businesswould send a powerful message to the rest of the market that theSEC is serious about attempting to address ratings shopping,” saidJeffrey Manns, an associate professor of law at George WashingtonUniversity in Washington.

A suspension would be the SEC's toughest punishment yet againstone of the three-biggest credit raters, which have been blamed forfueling the 2008 financial crisis by giving top ratings tosecurities that later soured. S&P's parent, New York- basedMcGraw Hill Financial Inc., disclosed in July that SECinvestigators were pursuing an enforcement action tied to CMBSdeals it rated in 2011.

Catherine Mathis, a spokeswoman for McGraw Hill, declined tocomment, as did John Nester, a spokesman for the SEC.

“As we stated in our third-quarter earnings, we're in activediscussions with the SEC to resolve matters that are pendingthere,” Chief Executive Officer Douglas Peterson said at aninvestor conference yesterday.

The deal that triggered the turmoil at S&P began withcontroversy. S&P stamped AAA ratings on parts of a deal thatoffered investors less of a cushion against losses than the ratingsfirm had allowed on similar transactions. That raised concern thatS&P was caving in to issuers to win business and leading bondbuyers to question the ratings company's methodology. Analysts ledby Barbara Duka, who was the head of the CMBS group at the time,held a conference call to field questions from investors on howthey were assessing risks of the deal.

Revised Criteria

Goldman Sachs Group Inc. and Citigroup Inc. subsequentlyrejiggered the transaction to boost investor protections,increasing the buffer that protected AAA securities from loandefaults by adding to the amount of lower-ranked debt that wasfirst to absorb losses. The banks then placed the deal withinvestors, only to pull it a week later when S&P withdrew itsrating, citing a discrepancy in its models.

The next month, S&P said the conflict wasn't significant andit would resume grading the sector. The rater didn't win any CMBSbusiness for more than a year, then revised its ratings criteria in2012 before re-entering the market.

Since the pulled deal, S&P has primarily rated single-borrower transactions, in part because it uses a methodologyallowing for a more optimistic outlook on a building's future valuethan that employed by Moody's Investors Service, according tobankers that arrange CMBS deals. That opinion allows lenders tobuild smaller investor cushions and increase their profits.

Without S&P, which has graded 75 percent of single-borrowerdeals in 2014, issuance of the securities may decline next yearsince Moody's and Fitch Ratings require higher credit enhancementlevels, according to a Dec. 9 Nomura Holdings Inc. report.

When raters establish tougher criteria, banks can find otheroptions. Wall Street started dropping Moody's CMBS grades last yearafter the company demanded greater investor protections to balanceincreasingly risky loans.

Ratings shopping has become systematic in 2014 as lendingguidelines loosen further, leaving investors more exposed toborrower defaults and making new offerings appear safer than theyreally are, according to Credit Suisse Group AG.

“Most default and loss models are underestimating the ultimatelosses on these deals,” the analysts led by Roger Lehman said in aNov. 21 report.

During the housing bubble that began to burst in 2006, ratingsshopping fueled a “race to the bottom” among the companies to avoidlosing market share, the U.S. Senate's Permanent Subcommittee onInvestigations said in a 2011 report.

The credit-grading business was then targeted by lawmakers inthe 2010 Dodd-Frank Act to examine whether its business modelsneeded to be changed. The SEC decided to keep the model in place inAugust, opting instead to increase internal controls and boostdisclosures.

Bloomberg News

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