(Updates with company comments in fifth paragraph.)
Sept. 26 (Bloomberg) -- Standard & Poor’s, the world’s largest provider of credit ratings, may face U.S. regulatory sanctions in connection with its rating of a $1.6 billion collateralized debt obligation in 2007.
The Securities and Exchange Commission’s so-called Wells notice may lead to the agency’s first action against a ratings firm for giving top grades to mortgage-backed securities before they plummeted in value. McGraw-Hill Cos., S&P’s parent company, said in a regulatory filing today that it received the notice Sept. 22 that the SEC may seek penalties including disgorgement of fees related to a collateralized debt obligation known as Delphinus CDO 2007-1.
Delphinus was highlighted in a U.S. Senate panel’s report as a “striking example” of how banks and ratings firms branded mortgage-linked products safe even as the housing market worsened in 2007. S&P rated six tranches of Delphinus AAA in August 2007 and began downgrading the securities by the end of the year, according to the Permanent Subcommittee on Investigations report released in April. By the end of 2008, they were rated as junk, according to the report.
Ratings firms have been faulted by lawmakers, regulators and investors for fueling the 2008 credit crisis by giving inflated grades on debt linked to risky loans. The Dodd-Frank Act, passed in response to the crisis, required the SEC to set up an office to oversee raters including New York-based S&P and its rivals Moody’s Corp. and Fitch Ratings Ltd.
Fitch, a unit of Paris-based Fimalac SA, hasn’t received a Wells notice regarding the Delphinus CDO, said Daniel Noonan, a spokesman for the company. Moody’s also hasn’t received a notice about the deal, said Michael Adler, a spokesman for the New York-based rater.
The SEC has previously sanctioned others involved in the mortgage securitization stream, from loan originators to the banks who bundled them into securities for sale to investors.
About three-quarters of Delphinus, which was underwritten by Mizuho Financial Group Inc. and managed by Delaware Asset Advisors, was based on subprime mortgages, according to a Fitch Ratings Ltd. report. Magnetar Capital Partners LLC invested in the deal, according to a ProPublica report. Steven Lipin, a spokesman for Magnetar, didn’t return a call seeking comment.
Mizuho, Japan’s third-biggest lender by market value, stepped up its activity in U.S. mortgage-backed securities in late 2006 and 2007, just as the housing market began its steep decline. As defaults on subprime home loans climbed, Mizuho struggled to find buyers for its CDOs and, as their values plummeted, had to absorb losses.
‘Game Was Over’
“Everybody knew the game was over well before then,” said Gene Phillips, a director at New York-based consulting firm PF2 Securities Evaluations Inc. “Banks were actively trying to get deals done to clean up their balance sheets.”
Masako Shiono, a spokeswoman for Tokyo-based Mizuho, didn’t return an e-mail seeking comment sent outside regular business hours in Japan.
In e-mails released by the Senate investigations panel led by Michigan Democrat Carl Levin, some S&P analysts questioned whether the Delphinus bonds deserved top grades. The analysts said the securities backing the deal were different from what bankers had described, according to the report.
“Um ... looks like the remaining portion is actually all sub-prime,” one analyst wrote.
“Do you want to address this with them, or let it go?” another replied.
A Wells notice is neither a formal allegation nor a finding of wrongdoing, McGraw-Hill said in its statement. S&P has been cooperating with the SEC in the matter and intends to continue to do so, according to the statement.
“They’ve won every lawsuit anybody has thrown at them and they’ve managed to answer every question the SEC has asked in the past,” said Edward Atorino, an analyst who follows McGraw- Hill at Benchmark Co. in New York.
CDOs are pools of assets such as mortgage bonds packaged into new securities in which interest payments on the underlying bonds or loans are used to pay investors.
--With assistance from Finbarr Flynn in Dublin and Jody Shenn in New York. Editors: Gregory Mott, Steve Dickson
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