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Catch a falling Morningstar?

BIScom Subsection: 
Author: 
Editorial Staff

Morningstar has been mounting a persistent advertising campaign on LinkedIn recently. It it, it promotes its due diligence services. An announcement by the USA's Securities and Exchange Commission raises several questions, not the least of which is "who or what is Morningstar"?

Yesterday, the USA's SEC said "The Securities and Exchange Commission today filed a civil action alleging that former credit ratings agency Morningstar Credit Ratings LLC [breached] disclosure and internal controls provisions of the federal securities laws in rating commercial mortgage-backed securities"

It's that word "former" that first catches the eye.

At the Morningstar website, a page headed "ratingagency.morningstar.com" says "Morningstar Credit Ratings, LLC (“Morningstar”) no longer operates as a credit rating agency. Effective November 23, 2020, DBRS, Inc. no longer identifies Morningstar as a credit rating affiliate. Morningstar no longer updates or maintains the historical content or information regarding previously withdrawn Morningstar credit ratings that is available on this website.

Morningstar continues to maintain the relevant DealView and Lead Generator products, which can be accessed via the DealView link above. " It reinforces its message:

Morningstar Credit Ratings, LLC (“Morningstar”) has withdrawn all of its credit ratings. Morningstar does not issue or monitor credit ratings. Morningstar no longer updates or maintains the historical content or information regarding previously withdrawn Morningstar credit ratings that is available on this website. For information on DBRS Morningstar credit ratings (including successor DBRS Morningstar credit ratings), please visit: https://www.dbrsmorningstar.com.

Information regarding previous Morningstar credit ratings, previous Morningstar rating methodologies, research, commentaries, and historical information will be retained on this website for the following specified lengths of time:

Rating history of previous Morningstar ratings: in accordance with applicable regulatory requirements;
Rating action announcements associated with previous Morningstar ratings: three years from the date of announcement;
New issue rating reports associated with previous Morningstar ratings: three years from the date of issuance of the rating report;
Surveillance rating reports associated with previous Morningstar ratings: three years from the date of issuance of the rating report;
Previous Morningstar rating methodologies and guidelines: three years from the date when the methodology or guideline was archived;
Events, external news, and videos: three years from the date of publication on this website;
News releases: three years from the date of publication on this website website;
Research commentaries: three years from the date of publication on this website.

And, as if that's not enough, the same page goes on to say "Effective November 23, 2020, Morningstar is no longer registered with the United States Securities and Exchange Commission (“SEC”) as a nationally recognized statistical rating organization (“NRSRO”); nor does it operate as a credit rating affiliate of DBRS, Inc. Morningstar no longer issues or monitors credit ratings. Previous Morningstar credit ratings have been withdrawn and there are no Morningstar credit ratings outstanding. Notwithstanding any disclosure or information to the contrary that may appear in any rating letter, presale report, post-sale report, press release, rating announcement, research or commentary published, delivered or disseminated by or on behalf of Morningstar prior to November 23, 2020, previous Morningstar credit ratings no longer maintain their status as NRSRO ratings. As of November 23, 2020, Morningstar no longer updates or maintains the historical content or information regarding previous Morningstar credit ratings that is available on this website. https://ratingagency.morningst... ."

But, there's this: "The DBRS Morningstar group of companies are wholly-owned subsidiaries of Morningstar, Inc."

In November 2020, dbrsmorningstar.com issued a press release. It said "DBRS Morningstar announced today the conclusion of its analytical integration of DBRS, Inc. and Morningstar Credit Ratings, LLC (MCR) that began in July 2019, when Morningstar, Inc. successfully completed the acquisition of DBRS. The acquisition further strengthened the world’s fourth-largest global credit rating agency currently located in eight offices with approximately 700 employees. Today’s announcement is the forty-third press release the global credit rating agency released to offer a maximum of transparency and to keep the market updated on the progress of its analytical integration... DBRS Morningstar currently maintains public credit ratings on 1,376 classes of debt across 484 transactions in the European structured finance sector, and public credit ratings on 382 classes of debt across 123 transactions in the Canadian structured finance sector. DBRS Morningstar currently publicly rates 318 corporate issuers, 160 financial institution groups, and 47 sovereign, sub-sovereign, and supranational issuers. "

The takeover of DBRS, a Canadian credit ratings firm, for USD669 million from venture capital groups Carlyle and Warburg Pincus was announced in May 2019. The purchase price fits the traditional calculation of four times gross income (USD167m x 4 = 668).

Morningstar started as an equity research business. We used to come across it as named in pump and dump scams in the early 2000s where its published material would be used to support widespread market fraud, especially in light-regulation markets in the USA such as The Pink Sheets.

Later, in 2009 it moved into credit rating and described itself a as "non-Nationally Recognized Statistical Rating Organisation". In 2010, it took over Realpoint which specialised in commercial mortgage-backed securities.

Announcing the DBRS deal, Morningstar said

As a long-term key product area for Morningstar, its credit rating activities have since expanded to include residential mortgage-backed securities (RMBS), agency risk transfers, single-family rentals, asset-backed securities (ABS), collateralised loan obligations (CLOs), corporate securities, financial institutions and real estate investment trusts (REITs).

In May 2019, Morningstar Chief Executive Officer Kunal Kapoor said "DBRS and Morningstar share research-centric cultures committed to rigor and independence. Together, we believe we can elevate the industry with the world’s first fintech ratings agency backed by state-of-the-art models, modern technology, and expert research teams that issuers and investors can count on to deliver transparent and independent ratings."

But there was a problem that had been festering within Morningstar Credit Ratings LLC since 2009, according to the SEC.

In relation to commercial mortgage-backed securities, the SEC says

According to the complaint, in 30 commercial mortgage-backed securities transactions totalling USD30,000 million that Morningstar rated from 2015 to 2016, the credit rating agency (sic) permitted analysts to make undisclosed adjustments to key stresses in the model that it used in determining the rating for that transaction. The complaint also alleges that Morningstar failed to establish and enforce an effective internal control structure governing the adjustments for a total of 31 transactions.

According to the complaint, analysts frequently made these undisclosed adjustments to reduce the stress applied in the model and, by easing the stresses, Morningstar lowered the credit enhancement it required for many of the ratings it awarded classes of the commercial mortgage-backed securitiestransactions. This, the complaint alleges, in certain instances benefited the issuers that paid for the ratings because it enabled those issuers to pay investors less interest than they would have without the adjustments.

Fifty shades of accounting as seen in relation to the Collateralised Debt Obligations that were such a factor in the creation of the global financial crisis that started with poor lending decisions in the mid 2000s and was already beginning to cause problems in 2005 when banks bought bundles of poor quality debt backed with outrageously bad (i.e. far too good) ratings not based on adequate investigation of what was in the bundles.

The SEC persists in using the word "charge" when it is actually suing in a civil action. It is seeking "injunctive relief, disgorgement with pre-judgment interest and civil penalties."

So, pay attention: when you read, later, in other media of "fines" it's not a fine. And no one is being prosecuted: it's a regulatory, not criminal, action.

Morningstar's mediaroom is, at the time of writing silent on the SEC's announcement and we were unable to find any earlier statement about the investigation. Its response to the SEC's allegations are, therefore, unknown. But there might be at least an indication as to the likely response: in May 2020, Morningstar Credit Ratings (a different subsidiary) "entered into a settlement with the United States Securities and Exchange Commission to resolve an investigation into whether certain activities of Morningstar Credit Ratings's asset-backed securities staff in 2015 to 2016 complied with sales and marketing rules applicable to Nationally Recognised Statistical Rating Organisations. "

The media statement says that the company will pay "USD3.5 million as part of the settlement [and] did not admit or deny the SEC's charges. Morningstar Credit Ratings cooperated with the SEC's multi-year investigation and believes the settlement is in the best interest of the company. There are no allegations that any credit ratings issued by Morningstar Credit Ratings were affected by the conduct described in the settlement."

On 8th February, it announced that Morningstar Investment Adviser Singapore Pte. Limited " has been appointed by Singapore’s state pension fund, Central Provident Fund Board, as the sole investment consultant under the CPF Investment Scheme from 7 March, 2021."

While the current action is against Morningstar Credit Ratings LLC, which as noted above no longer provides credit rating services, those services were backed into what is now DBRS-Morningstar.

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Links: https://www.dbrsmorningstar.co...

https://www.sec.gov/news/press...

https://newsroom.morningstar.c...

https://newsroom.morningstar.c...

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