Standard & Poor's Ratings Services is staring at fraud charges related to its ratings to six commercial mortgage backed securities (CMBS) in 2011. The Securities and Exchange Commission’s enforcement division has sent a Wells notice to the parent company McGraw Hill Financial Inc. , which however is not a guarantee that the SEC will bring up the charges. S&P is optimistic because it has “the opportunity to provide its perspective and to address the issues raised by the SEC before any decision is made”.
Bloomberg notes that “S&P rated six commercial-mortgage bond deals in 2011, according to a report from Morgan Stanley. They included three that pooled loans from borrowers across the U.S. and three tied to a single borrower, such as a $1 billion transaction linked to retail properties acquired by Blackstone Group LP”.
The enforcement action for alleged securities fraud comes on the heels of S&P facing a $5 billion fraud lawsuit. The lawsuit filed by the Justice Department related to inaccurate mortgage-bond grades.
Charges Against S&P
The charges are against the CMBS rankings and “public disclosure made by S&P regarding those ratings thereafter”.
According to Bloomberg, “S&P pulled assigned grades three years ago on the offering from Goldman Sachs Group Inc. (GS - Free Report) and Citigroup Inc. (C - Free Report) , prompting the banks to abandon the deal after it was placed with investors. S&P yanked the rankings after discovering potential discrepancies in how its methodology was being applied, the company said at the time. The credit grader then halted rating any new commercial-mortgage bonds, saying it had to review a potential problem in its model. That August, the company said the conflict had turned out not to be significant and it would resume grading deals”.
Following the trouble, S&P had stayed away from the commercial-mortgage backed securities market. However in 2012, S&P revised its criteria. The rating agency reshuffled senior management and changed the commercial real-estate deals’ ratings methodology.
If S&P is found guilty now, it may be subjected to actions such as civil monetary penalties or even a cease-and-desist order.
Separately, the U.S. Department of Justice filed lawsuit in Feb 2013 alleging S&P of inflating grades on commercial mortgage bonds in order to win business.
Safe Mortgage Funds to Buy
The fresh charges against S&P related to its ratings to six commercial mortgage backed securities may deter investor mood. The whole episode could have a large detrimental effect on investments in mortgage bond funds. However, we will pick 3 top rated mortgage funds that are safe investments. These mortgage funds carry a Zacks Mutual Fund Rank #1 (Strong Buy) as we expect the funds to outperform its peers in the future.
Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.
The funds have healthy year-to-date returns and also have proven history of decent returns over the last five years.
Loomis Sayles Securitized Asset Fund (LSSAX - Free Report) seeks high current income along with preservation of capital. The fund invests most of its assets in mortgage-backed and other asset-backed securities. The fund invests in commercial asset-backed securities. It may also invest in loans from automobiles, credit cards, home equity loans, manufactured housing, and other asset-backed securities.
The fund has returned 4.4% year to date and has a five-year annualized return of 7.8%.
BlackRock Allocation Target Shares Series C (BRACX - Free Report) seeks to boost return along with efficient investment management and income generation. The fund invests in securities including commercial and residential mortgage-backed securities, asset-backed securities, corporate bonds, notes and debentures among others. The securities may also include obligations from foreign governments and organizations like the World Bank.
The fund has returned 6.6% year to date and has a five-year annualized return of 7.9%.
Voya Intermediate Bond Portfolio Class I (IPIIX - Free Report) invests a lion’s share of its assets in bonds that includes mortgage, corporate and government bonds. These bonds are investment grade at the time of investment. The fund may invest in high-yield debts, but will retain an average portfolio with a minimum of investment grade.
The fund has returned 4.9% year to date and has a five-year annualized return of 7.5%.
To view the Zacks Rank and past performance of all mortgage funds, investors can click here to see the complete list of funds.
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