- 10 Oct 2012 at 7:19 PM
There are many great businesses in the world but surely none is as great as being paid money not to do stuff. I was in that line of work for two glorious months in the summer of 2011 and I’m pretty sure it was the peak of my career. Counterintuitively this business is not always massively scaleable,1 but there are some examples. My favorite is that in the 1980s companies would pay Skadden Arps a retainer fee to prevent Skadden from representing a hostile acquirer; I have idly suggested that David Einhorn look into charging similar fees to direct-marketing companies who want peaceful earnings calls.
If I were Moody’s I’d have a sliding scale of CMBS fees that goes like:
- Undeserved good rating: $3X
- Fair rating: $2X
- No rating: $X
- Random petulant sniping at a deal not actually rated by Moody’s: still free!
J.P. Morgan seems to have opted for false economy:
Moody’s Investors Service on Wednesday lashed out against ratings on a $1.1 billion commercial mortgage-backed security issued last month, noting the current grades leave investors at far greater risk than evaluations by other firms, notably Standard & Poor’s.2
The Moody’s Corp. unit argued the credit protection on the J.P. Morgan Chase & Co. deal is deficient and some bonds carrying investment-grade ratings should have been rated in junk territory. Moody’s was passed over for rating the multiloan “conduit” deal, breaking the lock it has had on conduits, which constitute the bulk of the market, for more than a year.
Boom! Or something? I don’t know. The Moody’s report3 is, as they prominently note, based on public information, including the deal’s prospectus. It is a mix of technical CMBS-construction complaints like:
Given its size of less than 3% of the pool balance in relation to a highly concentrated loan pool of uneven quality, we believe that Class E has a higher than investment-grade risk of default, as well as a higher than investment-grade risk of loss given default. The default of only one or two average-sized loans after the depletion of credit enhancement could lead to 100% severity on the class. We address the risks associated with such small subordinate classes by only rating classes that are sufficiently thick or that have a higher level of protection from the first dollar of loss, or both.
And just, like, punting on the commercial real estate market, like:
The five largest loans receiving no enhancement [at S&P] are secured by retail properties. The retail sector is undergoing significant transition, with store closings and re-sizings owing to factors including the rapid growth of online shopping. Their location in secondary or tertiary markets, combined with their generally high levels of tenant concentration and impending lease expirations, generate a high level of volatility of income and value and, in the event of default, a potentially high severity. …
The recent use by some market participants and adoption by Standard & Poor’s of lower, more market-based cap rates is extraordinarily risky in this environment of historically low interest rates because doing so fails to fully recognize refinancing risk. … While current market capitalization rates are appropriate for analyzing the credit of a loan maturing in ten days, they are not appropriate to analyze the risk of one maturing in ten.
One question is, if you were a buyer of these things, and you thought to yourself, “I’d eyeball these Class X-A certificates at around T+220,” and then Moody’s came out with this bombshell or eggshell or whatever it is, would you change your mind? Has anything changed? Presumably you are buying CMBS in part because you have a view on things like the future of the retail sector and cap rates; likely your view of those things has more money riding on it than Moody’s does. So, I mean, you did your research, right? And it’s not like you’re surprised that the Class E tranche, if that’s your thing, is thin: again, right there on the cover of the prospectus.4
Regardless of the strength of that argument, though, people clearly care about ratings. This deal managed to get four of them despite omitting Moody’s; welcome to the big leagues, Kroll! Your model of why they care about ratings can be as idealistic (?) as “they think that ratings agencies are superb evaluators of structured credit risk and so they rely on the agencies’ opinions,” or as cynical as “they have charters or regulators or capital requirements that are ratings-based and so they look for the maximum yield in any given ratings category.”
The idealistic view suggests that investors should want ratings agencies to use good models, demand sensible structures, and make thoughtful judgments about the future. That, in turn, suggests that agencies who do that should have a competitive advantage over agencies who don’t, and that investors should demand not just AAA-rated paper but paper rated AAA by an upstanding agency whose Special Comments they read and agree with. Which in turn argues for putting out Special Comments whenever you have Something Important To Say. About someone else’s deal.
On the other hand, if investors just want the highest possible yield for a plausible AAA, well, four AAAs plus yield would seem to beat five AAAs plus a bit more credit enhancement, or four AAAs and an AA+ for that matter.5 This little stunt would not endear Moody’s to JPMorgan or S&P, of course, but in the cynical model it wouldn’t endear them to investors either.
The fact that they did it suggests that Moody’s, at least, believes that the idealistic model is the correct one: they think that being amusing public hard-asses will win them more business through investor pressure than it will lose them through investor, um, preference for high ratings on sketchy stuff. Of course, Moody’s is kind of structurally set up to believe the idealistic view – nobody really comes to work thinking “my function in life is to be tricked into giving a stamp of approval to a sub-par product” – but still, it’s a hopeful sign. Maybe they’re even right.
Moody’s Blasts Commercial-Mortgage Bond Offering It Didn’t Rate [Bloomberg]
Moody’s Faults Ratings on J.P. Morgan Mortgage Bond [WSJ]
Special Comment – US CMBS: J.P. Morgan Chase Commercial Mortgage Securities Trust 2012-C8 Under-Enhanced Relative to Assigned Ratings [Moody’s, gated]
J.P. Morgan Chase Commercial Mortgage Securities Trust 2012-C8 [Edgar]
1. Right? What are your marginal costs when you scale up from doing nothing once to doing nothing a million times? Someone should, like, build an app or something.
2. It’s not just me – that sentence makes no sense at all, right? Just checking.
3. I think that makes you log in. Sorry!
4. Er actually page S-2. Actually I am fascinated by a piece of securities-law dorkery, which is that the junior classes here are “non-offered certificates,” which appears to mean not “we’re not selling them” but rather “we’re selling them 144A.” Is that standard in CMBS? Is it like, AAA investors need registration but mezz-ish investors don’t? Why do you skip registration on the junior tranches – just avoiding SEC fees? [Update: a reader writes “Underwriter financing those tranches and so don’t want them subject to 11(d)(1), which generally limits an underwriter’s ability to finance the purchase of securities it underwrote in first 30 days.”] Don’t you worry about integration and “general solicitation” when there’s complete information about the “non-offered” junior tranches in the prospectus. Anyway.
5. That’s a bit loose; Moody’s is complaining more about the lower-rated tranches, especially the BBB- Class Es, than the AAAs.
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- Bess Levin
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