By Cezary Podkul
In November, an S&P Global Inc. employee briefed Senate Banking Committee staff members on the growing risks in the $1.2 trillion market for loans that finance private-equity buyouts.
In a meeting with Democratic Senate staff, Andrew Park of S&P laid out how the speculative debt would face a torrent of credit-rating downgrades once the economy turned. That would hurt investors who bought bonds secured by the loans, many of which are rated by S&P.
A few weeks after the meeting, one of S&P's Washington lobbyists called Mr. Park and demanded to know why he attended the meeting and what was discussed, according to Mr. Park. On Jan. 6, the firm fired Mr. Park for failing to clear his presentation with compliance staff. That was a violation of a company policy requiring such clearance, S&P said in a response to a wrongful-termination complaint filed by Mr. Park.
The coronavirus pandemic made Mr. Park's warnings look prescient. Downgrades of loans owed by heavily indebted corporations have spiked sharply since February, eclipsing levels seen during the financial crisis, according to S&P. More than 1,600 bonds tied to loans owed by risky borrowers have been put on watch for downgrades by S&P, Moody's Corp. and Fitch Ratings. While deteriorating economic conditions have hit businesses hard, the wave of downgrades calls into question the accuracy of at least some of the original ratings.
Mr. Park filed his wrongful-termination complaint against S&P under the federal government's whistleblower laws, saying he was retaliated against for giving information to the Senate staffers. He now works for Americans for Financial Reform, the organization that arranged the November briefing and which lobbies for tighter financial regulation, including of credit-rating firms.
Mr. Park, 33 years old, told the Democratic Senate staffers that one source of risk was companies gaming the system by hiring the ratings firms that tend to give their bonds the highest grades. Mr. Park didn't work for S&P's bond-rating unit, but in his work as a senior editor at an S&P-owned news service that covered corporate lending, he frequently saw signs of this taboo behavior, which both issuers and ratings firms acknowledge happens but which they don't like discussing.
"Word got out about how I was speaking about rating shopping, and I was fired," Mr. Park said in an interview.
S&P said in a statement that it did nothing wrong in firing Mr. Park and that it will "vigorously defend against all claims" in his complaint, which was filed with the Occupational Safety and Health Administration.
Regulators have been sounding alarms about the market for the risky corporate debt, known as leveraged loans. Last May, Federal Reserve Chairman Jerome Powell said loosening lending standards have spurred growth in borrowing that was outpacing companies' ability to repay.
The following month, S&P relaxed the ratings criteria it uses to evaluate collateralized loan obligations, or CLOs -- a type of bond whose payments are tied to pools of leveraged loans. The new criteria reduced default expectations for loans backing CLOs. S&P said in a statement that additional data and the evolution of the CLO market justified the move.
CLO issuers are the biggest buyers of leveraged loans, making them an important intermediary between private-equity firms looking to finance takeovers and investors willing to bankroll them. Ratings firms stand in the middle, and their grades are a crucial input into the profit calculations of CLO issuers, who pay for the ratings.
S&P's market share in U.S. CLOs rose from 51% in the first half of 2019 to 71% after the methodology change, vaulting over Fitch and Moody's for the first time in five years, according to industry tracker Asset-Backed Alert. CLO deals usually get rated by two firms.
The ratings enable bankers to slice the pools of loans, which are typically rated junk, into bonds with various levels of risk. The riskier, lower-rated slices are first in line to suffer losses and can earn higher returns than the safer pieces. The safest pieces are rated triple-A.
But investors rarely get a complete picture of the risks because issuers selectively disclose the best ratings on each bond, leaving CLOs with patchworks of missing grades. Ratings firms enable the selective disclosure by allowing issuers to decide which of their grades get published. In the past, some ratings firms insisted on making that decision themselves.
In one 2019 deal, an issuer switched between Moody's and S&P so many times that the two firms' grades on the deal's eight bonds resembled a checkerboard. A person familiar with the matter said the issuer, Bain Capital Credit, used the different ratings firms to lower borrowing costs, a practice that is common in the industry. S&P declined further comment beyond its statement on Mr. Park's termination. Moody's didn't immediately respond to a request for comment.
It was patterns like these that Mr. Park was noticing at his job at S&P. He had studied finance in college and worked as an analyst for Pacific Investment Management Co., the massive bond-fund manager. In 2015, he joined S&P, where his main task was to summarize details of CLO deals. When he wrote up Bain's 2019 deal, a reader inquired to ask if the ratings were a typo, Mr. Park recalled.
In late October, after he took a few days off to get married, Mr. Park got an email from Marcus Stanley, policy director for Americans for Financial Reform, inviting him to speak about CLOs to some staffers for Sen. Sherrod Brown (D., Ohio), the ranking member on the Senate Banking Committee. Mr. Park had met Mr. Stanley at a Washington event a few weeks earlier and was familiar with his organization. Mr. Park realized that it wasn't normally a reporter's job to give such presentations, but he figured that it would be a good opportunity to develop sources, so he agreed.
"You're going to be thankful you met me," Mr. Stanley told Mr. Park as they entered a Senate office building for the meeting, according to Mr. Park.
Mr. Park created a 20-slide PowerPoint presentation, which he brought to the meeting. In it he explained that while CLOs held up during the 2008 financial crisis, there were signs that they wouldn't do the same the next time the economy crumbled. He said loose borrowing standards masked the degree of debt that companies were taking on, making downgrades -- and losses for CLO investors -- more likely in the event of a recession.
Rating shopping wasn't a part of Mr. Park's presentation, but the topic came up during the discussion, according to Messrs. Park and Stanley and another guest at the meeting. Mr. Park said he was asked a question about rating shopping and answered it honestly based on his experience.
On Dec. 3, Sen. Brown sent a letter to banking regulators asking for more oversight of leveraged loans and CLOs. He wrote that "in yet another echo of the 2008 crisis, market participants have reported concerns of ratings shopping." The letter footnoted an S&P presentation to his staff, though it didn't directly attribute the information to Mr. Park.
A few days later, Kellin Clark, one of S&P's lobbyists, called Mr. Park and asked about the meeting, including whether rating shopping came up, according to Mr. Park. Mr. Clark referred an inquiry to S&P, which didn't comment on the exchange.
By early December, credit ratings were getting attention in Washington. Lawmakers began asking the Securities and Exchange Commission about boosting oversight, and one of the agency's advisory committees had started examining alternative ratings business models that would lessen the industry's conflict of interest.
When Mr. Park traveled to New York from Washington for his S&P unit's holiday party in mid-December, the firm's compliance staff placed him on leave while they investigated. They faulted Mr. Park for not clearing his presentation with compliance before attending the meeting, documents from his wrongful-termination complaint show. Mr. Park says he didn't think he needed to since most of the slides had already been cleared before for previous presentations or referenced publicly available data.
In March, Mr. Park joined Americans for Financial Reform to work for Mr. Stanley. Mr. Stanley said he hired Mr. Park because of his detailed understanding of leveraged loans and financial markets. "That's why I sought him out," he said.
Leveraged-loan defaults spiked to a record in April, according to S&P. As of May 17, more than 28% of loans packaged into CLOs have either been downgraded, placed on watch for possible downgrade or both. About 10% of S&P-rated CLO bonds are on watch for potential downgrades.
The SEC's advisory panel examining alternative ratings business models recently got a letter from S&P. The firm argued that no change is needed because "there is nothing to indicate" that the ratings industry's conflicts of interest haven't been mitigated by postcrisis reforms.
Write to Cezary Podkul at firstname.lastname@example.org