Standard & Poor's Ratings Services on Monday proposed changes to the way it rates new and outstanding commercial mortgage-backed securities in a bid to entice investors and issuers to use its ratings after banks have shunned the firm for nearly a year.
S&P, a unit of McGraw-Hill Cos. (MHP), said the highly anticipated proposal would trigger upgrades on about 10% of its ratings, while 15% may face possible downgrades. The average ratings change is estimated at about 2.5 notches.
The proposed criteria would have no effect on roughly three-quarters of deals the firm rates. Harris Trifon, a CMBS strategist at Deutsche Bank, said in a research report that "at first glance, it seems the magnitude of the changes will disappoint most investors."
Some investors were expecting S&P's new rating standards to trigger more upgrades of outstanding deals, as a 2009 revamp led S&P to rate certain deals more conservatively than its top rivals, Moody's Investors Service and Fitch Ratings.
S&P analysts Monday highlighted the importance of what they called a "qualitative overlay" in the proposed standards that isn't spelled out in the current criteria. That would allow S&P analysts to tweak the so-called credit enhancement level, or the cushion needed to support a deal, based on their own judgment rather than relying solely on an analytical model.
S&P said that if analysts use the "qualitative overlay," the effect on the credit-enhancement level would "generally" be up or down by two percentage points and would be clearly articulated in rating reports so investors could track analysts' reasoning.
But some market participants said Monday that granting such leeway to analysts allows wiggle room that could result in more favorable ratings on forthcoming deals.
S&P hasn't rated any multiloan deal, the bread and butter of the commercial mortgage-backed securities market, since July 2011, when it took the unprecedented step of pulling a preliminary rating on a $1.5 billion issue at the 11th hour. That move, amid concerns about inconsistent rating standards between new and old deals, infuriated investors and the issuers, Goldman Sachs Group Inc. (GS) and Citigroup Inc. (C).
Market participants say they have been waiting since then for S&P to unveil its new rating standards. The absence of S&P in the CMBS market has allowed smaller rating firms to expand their market share, including Kroll Bond Rating Agency Inc. and Morningstar Credit Ratings LLC. Moody's has dominated the sector.
Some analysts remain skeptical the proposed standards will persuade issuers to hire S&P again on deals. "They have to do a lot more than this to restore confidence in their ratings and only time will allow for that," said Richard Hill, CMBS strategist at RBS.
In particular, investors would be upset if the rating criteria lead to downgrades among the most recent CMBS rated by S&P, Mr. Hill said. Others expressed hope that S&P would more aggressively address 2009 rating model changes that resulted in harsh downgrades and widened the gap between S&P and other rating firms.
For all CMBS originally rated AAA, just 55% have maintained the designation by S&P, according to Darrell Wheeler, head of CMBS strategy at Amherst Securities Group. Moody's still grades 81% of issues Aaa, while 98% of Fitch-rated CMBS still carry that firm's top rating, he said.
As part of an ensuing shake-up after the pulled rating, Peter Eastham, then Asia structured finance chief for S&P, took over from Barbara Duka, the lead analyst on the pulled CMBS deal.
Paul Coughlin, the firm's new head of global analytics and operations, told S&P's structured-finance employees earlier this year to focus on restoring confidence in ratings in the hopes of regaining market share, people familiar with the matter told The Wall Street Journal.
Mr. Eastham, now S&P's head analytical manager for U.S. commercial mortgage-backed deals, said Monday at a press conference that the proposals were meant to make S&P's criteria "more clear, more usable and more transparent" for issuers and investors. Mr. Eastham said the proposed criteria were a response to input from market participants in recent months.
He said the proposed changes were not meant to help S&P regain lost market share. "Competition is not relevant to this discussion at all," he said.
Market participants have until July 2 to offer feedback on S&P's proposed criteria. The firm will digest those responses and then publish final criteria, applying those revamped standards to new and outstanding deals.
Mr. Eastham said the final standards could be published as "quick as a handful of weeks" or longer, depending on the extent of the feedback.
The planned changes include instituting a single comprehensive framework for rating standalone, large loan and conduit/fusion CMBS transactions. The plans also include a lifetime default probability concept--mostly driven by each loan's S&P loan-to-value ratio and debt-service coverage.
The proposed criteria also would shift the approach to property analysis for U.S. and Canadian transactions to bring them in line with global criteria.