The Mortgage Bankers Association has notified the Securities and Exchange Commission (SEC) of its opposition to a proposed rule requiring the disclosure of preliminary ratings of securities. The rule could potentially affect many investors in commercial real estate securities.
The Washington, D.C.-based bankers group contends that disclosing preliminary ratings of commercial mortgage-backed securities (CMBS) carries the risk of providing misleading information to investors in commercial real estate.
The SEC is considering a number of steps to make the process of rating securities more transparent in order to protect investors. The proposed rule is intended to curb the practice of “ratings shopping,” which involves soliciting a number of rating agencies for a preliminary rating and choosing an agency based on the early rating that is most favorable.
The mortgage bankers group says that the composition of a group of loans can change substantially after it is initially rated, before the final selection of loans is made, so that the early rating often is no longer relevant for the resulting security.
“In the case of CMBS, the pool of properties comprising the securitization can change significantly from the initial pool that received the preliminary rating,” John Courson, president and CEO of the Mortgage Bankers Association told SEC Secretary Elizabeth Murphy. Therefore, disclosure of the preliminary rating information for a loan pool is unlikely to accurately reflect the final pool of loans that were securitized, Courson said.
“What this rule requires is that the preliminary rating be disclosed. On paper, it doesn’t sound like a bad idea but once you understand how a commercial mortgage-backed security works, it’s really not a good idea,” says George Green, associate vice president of MBA.
For example, if 100 loans are contributed to a pool and packaged into a commercial mortgage-backed security, the loans are stratified by rating and different investors buy different portions of the pool, says Green. Some tranches of the security may be rated AAA while others are rated BBB.
The investor who buys sub-investment grade tranches, below a B rating, can pick and choose and eliminate some loans from the original pool, which affects the final rating.
In addition, an initial rating can be very cursory, says Green. After rating examiners conduct due diligence and investigate the quality of the bundled loans, the final rating can also change.
The proposal to require disclosure of preliminary ratings of securities would amend statements filed under the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Company Act of 1940. After devastating losses throughout the CMBS and other securities markets over the past two years, the SEC is trying to assure that investors are properly informed before making investment decisions.
The agency called for comment on the proposed rule change, and now that the comment period is closed it will study the responses for several weeks or months before making a final determination on whether to require the disclosure of preliminary ratings.
In general, the mortgage bankers group supports transparency in the ratings process, says Green.
One way potential investors can learn more about CMBS is to weigh both solicited and independent ratings.
An emerging group of ratings agencies conduct unsolicited or independent ratings of securities. The agencies are not paid in the traditional way, by the issuer of the security, but by subscribers to the agencies’ services. The independent ratings have become increasingly popular.
“Really they are providing a second opinion of the issuer-provided ratings,” says Green. “They can then be compared to the ratings that were performed by the issuer-commissioned ratings. We see that as the way to resolve the problem.”