Bloomberg News

S&P Says Too Soon to Give Rental-Home Securities AAA Grades (2)

February 27, 2014

The McGraw Hill Inc. Headquarters

The Justice Department sued Standard & Poor and parent McGraw Hill Financial Inc. a year ago, seeking as much as $5 billion in civil penalties for losses to federally insured banks and credit unions who relied on the grader's claims that its ratings were free of conflicts of interest. Photographer: Victor J. Blue/Bloomberg

New securities backed by U.S. rental homes don’t meet the criteria for the highest credit grade, Standard & Poor’s said, going against at least three rivals.

S&P’s main concerns “revolve around the industry’s operational infancy, historical performance,” lack of testing under “extreme economic conditions and the ultimate liquidation values of the underlying properties, given the risks associated with short liquidation periods,” it said today in a report.

Moody’s Investors Service, Kroll Bond Rating Agency and Morningstar Inc. (MORN:US) assigned top grades to 58 percent of the bonds in a $479.1 million offering in November by Blackstone Group LP (BX:US)’s Invitation Homes, the only of its type so far. The market could fuel an unsustainable expansion of institutional rental-home investors if demand for the securities is too strong, according to a report today by the Center for American Progress, a Washington group typically aligned with Democrats.

Wall Street ultimately may sell more than $20 billion a year of rental-home bonds, according to Ryan Stark, a director at Deutsche Bank AG, which structured and helped underwrite the first transaction. Bank of America Corp. analysts forecasted $4 billion of issuance this year in a 2014 outlook, while Barclays Plc said sales “could easily be” $3 billion to $5 billion.

Housing Bubble

S&P “has yet to see” a transaction with portions warranting AAA grades based on the amount of risk protection including “credit enhancement,” New York-based analysts Rasool Alizadeh, Weili Chen and John Connorton III wrote in the report.

Those loss buffers can be tied to items such as classes of deals bearing losses before others, or collateral in excess of the amount of notes sold. The Blackstone transaction was backed by houses bought for $444.7 million and valued at $638.8 million.

“We were comfortable getting to Aaa on the first” Invitation Homes “deal because we believe that even if the borrower is unable to refinance the loan, sufficient value would be available from the sale of the properties in a liquidation scenario to pay off the bonds,” Kruti Muni, a senior vice president at Moody’s, said today in an e-mail.

Kroll was also willing to provide top grades to the securities based on its ability to gauge the potential minimum value of the underling homes, which it has experience with studying when rating traditional mortgage bonds, Glenn Costello, a senior managing director at the firm, said by telephone.

Inflated Grades

Ratings companies are assessing the market after being blamed for helping create the U.S. housing bubble and subsequent financial crisis in 2008 by granting inflated grades to mortgage bonds. The Justice Department sued S&P and parent McGraw Hill Financial Inc. (MHFI:US) a year ago, seeking as much as $5 billion in civil penalties for losses to federally insured banks and credit unions who relied on the grader’s claims that its ratings were free of conflicts of interest.

McGraw Hill has said it will defend itself “vigorously” against the “meritless” claims.

Institutional investors, led by companies such as Invitation Homes and American Homes 4 Rent (AMH:US), have bought as many as 200,000 U.S. properties in the last two years, taking advantage of real estate prices that fell by as much as one-third from the 2006 peak, and rising demand for rentals among Americans who lost their houses in the foreclosure crisis.

Fitch Ratings said in October it didn’t believe that rental-home securities should get top ratings now, citing in part the limited track record of big institutions in the business and incomplete historical data on how rents, vacancies and other considerations can vary over economic cycles.

The firm said in a statement then that it was also concerned the borrowing could be hard to refinance or to pay off with the proceeds of home sales that could potentially flood markets. If the single-family rental industry gets too big, it might not be sustainable because it could outstrip the capacity of managers to oversee homes or overinflate property prices, the Center for American Progress (0119163D:US) said.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net


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