Morningstar’s Bond-Scores Enterprise Is Underneath Fireplace From Regulators

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Dream time

Investors may know

Morning star

However, for rating mutual funds and stocks, the company is building a bond ratings business and is getting regulatory scrutiny for some of its practices.

The Securities and Exchange Commission sued

Morning star

(Ticker: MORN) on Tuesday, claiming its analysts used unknown techniques to assign higher ratings to some commercial mortgage-backed securities or CMBS.

Morningstar valued CMBS at $ 30 billion from 2015 to 2016, the SEC said. Its procedures enabled analysts to make “credit-specific” adjustments to stress tests on the securities. While the adjustments either increased or decreased cash flow projections and valuations, they were “largely used to ease those burdens,” the SEC said in its complaint.

This enabled Morningstar to assign higher ratings to CMBS classes. Multi-million dollar CMBS received investment grade ratings – an increase over ratings they would have received under the methodology published by Morningstar, the SEC said.

Morningstar issued a statement Wednesday denying the claims. “The SEC outperforms its regulator and violates the analytical independence of ratings,” she said. The SEC did not claim that investors were harmed by their practices, the company added. The rating techniques in question were last used in 2017. None of the securities assessed using the methodology are still outstanding, the company said.

Morningstar received bond ratings a few years ago and expanded its presence with DBRS, a ratings firm that was acquired for $ 669 million in 2019. Morningstar entered into a separate SEC enforcement action against its ratings business last May, agreeing to pay $ 3.5 million to settle fees the division violated a conflict of interest rule.

The new case underscores the fact that, despite years of regulatory efforts to tighten supervision and eradicate conflicts of interest in the industry, bond ratings are still a murky business.

Bond issuers routinely seek higher ratings in order to lower the interest rates they have to pay on securities. Issuers hire companies like Morningstar



S&P Global

to value their securities and create financial incentives on both sides of the transaction to keep bonds looking their best.

Bond issuers also seek investment grade ratings to expand the pool of eligible investors who can buy their securities. Pension funds, insurance companies, and other large investors who can only hold investment grade securities rely heavily on rating companies to assess credit risk in their fixed income portfolios.

While the industry is now more regulated, rating firms still have significant discretion in stress testing securities and assigning ratings. The assessment methods must be made public and submitted to the regulatory authorities. However, according to Morningstar, the SEC is not allowed to regulate the content or practices of rating firms as the SEC seeks to regulate “through enforcement.”

The SEC said it was within its legal rights to enforce disclosure requirements.

Anyway, Morningstar investors don’t seem concerned. The stock fell slightly to $ 251.32 in the last trade. It was a winner this year, gaining 8% and up 55% in the last 52 weeks. The

S&P 500

was down 0.7% in the last trade.

The company is expected to post a fourth quarter profit after Thursday’s close of trading.

However, if you’re wondering what to expect on Wall Street, you’re out of luck. Morningstar does not issue financial guidelines or host calls for earnings. Consensus estimates do not exist as the share is not covered by a single analyst, according to FactSet. Investors can ask questions of the company at its annual meeting in May.

While the company remains opaque, Morningstar is clearly committed to expanding the ratings business, which has become an important part of its growth. DBRS posted revenue of $ 53 million for the third quarter, up 7.5% year over year. Morningstar had sales of approximately $ 1 billion for the first nine months of 2020. DBRS contributed $ 150 million, making it one of the fastest growing businesses.

Write to Daren Fonda at [email protected]

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