David Jacob, who joined S&P in 2008 to head its structured-finance sector, says he ran monthly reports explaining to his boss why S&P wasn't selected to rate deals. The answer was almost always that its criteria were tougher than another's.
"Little by little it weakens," says Mr. Jacob, who lost his job in a reorganization in 2012 and is retired. "If you have the tightest criteria, who's going to use you?...The incentives are wrong. They stayed wrong."
Investors say ratings inflation is most evident in commercial-mortgage-backed securities, or CMBS, of which investors hold about $1.2 trillion. The Journal found DBRS rated these bonds higher than S&P, Moody's or Fitch 39%, 21% and 30% of the time, respectively. It rated bonds lower 7% of the time or less. Morningstar rated the bonds higher than the big firms at least 36% of the time and lower 2% to 8% of the time. Kroll showed similar trends.
When rating a security higher than their three big competitors, Morningstar, Kroll and DBRS were around two rungs more generous, on average. Some ratings were a dozen or more rungs higher, potentially the difference between junk bonds and triple-A.
A spokeswoman for Kroll and spokesman for Morningstar, which now owns DBRS, said there is a bias in the data because when smaller firms put forth more conservative feedback on where they might rate deals, they are often not chosen to rate them. DBRS and Morningstar say that if these unpublished ratings could be reflected in the data, the results might look different.
S&P and Moody's were about as likely to rate the same debt higher or lower compared with one another. Fitch showed a slight tendency to rate higher more often. Moody's and S&P declined to comment on the Journal's analysis. Fitch says "diversity in credit views is a positive for investors" who are "aware of the differences between rating agency criteria and make informed investment decisions accordingly."
Moody's, S&P and Fitch responded to increased competition by issuing higher ratings, according to two academics' study of 2,488 securities rated between 2009 and 2014. One author, Colorado State University Finance Professor Sean Flynn, says "competition among credit-rating firms has, if anything, reduced the quality of credit ratings."
In October 2015, Moody's eased its rating methodology for single-asset CMBS deals like the one in Maui. Moody's change led to upgrades of up to four rungs on some slices of about half of single-asset deals it rated. Its market share rose to 54% in the first half of 2016 from 28% during the second half of 2015, according to Commercial Mortgage Alert.
Fitch saw similar growth in another corner of the CMBS market in 2016 after giving itself wider latitude to use easier rating assumptions. The firm was hired on every multi-borrower CMBS deal in the second half of 2016, up from 80% market share during the second half of 2015. Fitch says: "This new criteria merely aimed to better reflect what we do."
Moody's ratings on riskier slices of these multi-borrower deals often weren't as favorable as those of its competitors. By 2015, issuers "essentially stopped soliciting our ratings" on those slices, according to a January commentary from the company.
Investors demanded higher yields on triple-B portions of deals without Moody's ratings than on triple-B slices that included Moody's during 2011 to 2014, according to a Journal analysis of Commercial Mortgage Alert data. The difference was about three-tenths of a percentage point more, on average, than benchmark triple-B rated CMBS -- which means it was costlier to borrow than comparably rated debt.
Adam Hayden, who manages a $13 billion securities portfolio at New York Life Insurance Co.'s real-estate-investment arm, was among the investors who met with the SEC in 2015. He said inflated ratings were a risk to market stability, according to a meeting memo obtained by the Journal.
The portfolio he manages holds about $10 million of a security called BACM 2005-1 Class B -- the bond backed by the Mall at Stonecrest mortgage. When sold in 2005, the bond contained around 140 mortgages and earned high grades. As mortgages were paid off, the debt pool shrank. Stonecrest's mortgage now accounts for 97% of the bond, according to commercial mortgage tracker Trepp LLC.
S&P downgraded the bond three times, keeping it at investment grade despite the default. Fitch in April downgraded the bond deep into junk territory citing "increased loss expectations."
Inside the mall, next to the former Payless ShoeSource, sits a storefront that until this spring housed a bookstore owned by Monique Hall. Sales were so weak she filed for bankruptcy, she says. "This particular mall," she says, "is on life support."
Craig Delasin, CEO of the mall's management company, Urban Retail Properties, says owners are finalizing a deal to extend the loan's maturity and that the mall is signing up new tenants.
Stonecrest Mayor Jason Lary in 2017 made an unsuccessful effort to attract Amazon.com Inc.'s new headquarters by offering to rename part of the city Amazon, Ga. He compares himself to a physician trying to help a sick patient. His prognosis for the mall: "a 50-50 chance of survival."
Write to Cezary Podkul at email@example.com and Gunjan Banerji at Gunjan.Banerji@wsj.com