S&P sets challenge to Moody's mortgage bond rating

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Standard & Poor's on Wednesday challenged rival Moody's Investors Service over its assessment of the first mortgage-backed securities deal since 2008, providing a snapshot of the rows unsolicited ratings might spark in the months ahead.

S&P said in a statement that characteristics of loans in the Redwood Trust residential mortgage bond fell short of its benchmark or "archetypical" issue whose senior bonds would be rated AAA if at least 7.5% of the deal is in a subordinate position.

The Redwood RMBS, which reopened a key housing credit market frozen since the onset of the financial crisis, sold with 6.5% subordination and a Aaa rating from Moody's, the only company hired to rate the issue. Heavy investor demand allowed underwriters to cut yields.

Moody's defended its rating, citing loan quality, a simpler structure compared with past RMBS, and that Redwood has power to ensure the loans were properly originated by CitiMortgage. Loans were also reviewed by an independent third-party, said Linda Stesney, a managing director at Moody's.

But disagreements over the bond have redirected the spotlight on the issuer-paid ratings model that critics say presents conflicts for raters who provide investors with views of a security's chances for default. Some investors may have asked S&P to gauge how much more restrictive it would have been under its model, one mortgage strategist said.

Under the issuer-paid model, many real estate-relate bonds got top ratings that did not fully capture the risks of the housing downturn or financial crisis.

"What we don't have is a change in the way people have done business," said Sadie Gurley, a managing director at Marathon Asset Management in New York. "You have the same investment banks taking the ratings that are most advantageous to them. You don't have independence of ratings, which are what we need regulators to address."

The unsolicited note by S&P may be a preview of what's to come in June when rating companies implement new Securities and Exchange Commission rules to encourage competition. Among those, any rating company paid to rate a structured security must make an issuer's data available to others via special a password-protected Web site.

The worry for issuers would be an unsolicited rating could undercut the assessment it paid for, causing investors to demand higher yields, according to a source that conducts due diligence on mortgage loans.

That could lead to more private issues to circumvent SEC rules, the source said. But liquidity may be a problem since many investors require two ratings before they can buy.