MBS Issuers Boycotting S&P

RBS, Wells Fargo and Bank of America are no longer using Standard & Poor’s to rate their mortgage-backed securities. The core of the dispute is how Standard & Poor’s has chosen to respond to Section 933 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The section holds agencies liable for losses if investors can prove that ratings were not based on reasonable assessments of underlying data.
Whereas all of the leading rating agencies – Moody’s Investor Services, Standard & Poor’s and Fitch Ratings – have sought indemnification in deal documents, Fitch and Moody’s have apparently been flexible while Standard & Poor’s has not.
Standard & Poor’s has gone so far as to claim the right to sue a bank if the agency’s ratings were based on incomplete or inaccurate information about a deal that the bank provided. ABAlert.com quotes a Standard & Poor’s insider as claiming, “We hold them liable for the accuracy of their information…That’s what they really don’t like.”
Standard & Poor’s is now working with the Securities Industry and Financial Markets Association to resolve their conflict with the banks.

Hong Kong Proposes New Credit Rating Agency Regulation

Hong Kong’s Securities and Futures Commission (SFC) has proposed new licensing and supervision of credit rating agencies. The stated goals, as quoted by Maureen Whalen when writing for Lexology, are to “mandate minimum conduct standards for CRAs, including requirements that credit rating activities be conducted in accordance with principals [sic] of integrity, transparency, responsibility and good governance” and “ensure that ratings prepared in Hong Kong continue to be serviceable in other jurisdictions, including for regulatory purposes.”
The proposed legislation would necessitate minimum capital requirements for all credit rating services activity, and credit rating agencies would be required to separate their credit rating business from other types of business.
The new rules are planned to be implemented by the end of January 2011. Comments on the proposal are due by August 20, 2010.

FOX Business Wonders Whether U.S. Deserves Its AAA

FOX Business has joined many European business analysts in wondering whether the U.S. deserves the AAA rating it has maintained since 1917. In light of how other advanced nations’ sovereign debt is being aggressively scrutinized and downgraded, there are those who feel the U.S.’s AAA rating is unwarranted.

FOX believes that the interest cost of the U.S. debt as a percentage of total federal tax revenues is the greatest concern for credit rating agencies. The U.S. needs to keep the interest cost to federal tax revenue ratio stable. This is why there is pressure to raise federal taxes to avoid a credit rating downgrade.

Moody’s says that the United States debt is currently affordable. After peaking at 10% two years ago, the ratio of interest payments to federal revenue has dropped to 8.7% in 2010.

EU Addresses Foreign Rating Agency Regulation

The European Union (EU) regulators envision two ways to handle ratings from agencies that come from non-member states. The first is to accept ratings of countries that they believe are “equivalent,” such as Japan.

The second way to is to accept ratings from other countries so long as their process is as “stringent” as in the EU and an EU agency has endorsed the assessments.

If the latter is imposed in a strict sense, it could affect both borrowers and lenders from other countries looking to engage Europeans institutions. Banks in particular could have a hard time holding non-EU assets as regulated capital under the new law.

The Financial Times quotes a worried diplomat as saying, “European banks could be shut out of certain capital markets…it’s not a small issue.” The United Kingdom and the Netherlands among other Nordic states are urging a loose interpretation of the regulation whereas France and Italy are pushing for a strict application.

EU Considering Ratings Agency Fines

Finance ministers from the European Union (EU) are considering penalties for ratings agencies that assess members’ sovereign debt inappropriately harshly.

Didier Reynders, Belgium’s finance minister, said, “It must be possible to penalize, if after some weeks or months it is possible to say it [a downgrade] was a wrong signal, what is the responsibility of the rating agency? It is quite difficult to say that there is no responsibility if it is possible to prove it was a wrong analysis, a wrong signal. The penalties are the capacity to impose some responsibility on the rating agencies.”

There is an increasing level of frustration with the rating agencies among the EU nations. The general feeling is that ratings agencies are outside the area of reasonable responsibility and their opinions do not encompass all the factors that help to mitigate sovereign debt risk. Yet a seemingly arbitrary downgrade can have devastating effects on nations’ cost to borrow and consequently their national budgets.

How to determine whether agency rating was “wrong” and the appropriate penalties are still open questions.

Shopping for Ratings

Good piece from the WSJ on how things have changed…or not…with regard to the conflict of interest that exists when the issuers are the ones that pay the fees of the rating agencies.  Whether ratings shopping, biases, etc. actually exist or not, the perception and possibility of this sort of behavior will always be present as long as the issuer pay system prevails.  A user pay system – where investors fit the bill for the ratings they use, not the issuer – removes all possibilities of this type of conduct. But is it viable as a commercial enterprise?

‘Ratings Shopping’ Lives as Congress Debates a Fix – Wall Street Journal, May 24, 2010

Rating Amendments Still Ongoing

If the SEC doesn’t like Moody’s methodology, why do we allow the ratings to dictate credit quality in investment policy, regulatory enforcement and public policy?

The ratings don’t measure credit quality, they measure “distance” to first dollar loss. The House bill tried to eliminate all reference to credit ratings from the federal register. The Senate version is not as comprehensive, but the amendment process is not over.

Moody’s Declines 8.1% After Disclosing ‘Wells Notice’ From SEC – Bloomberg, May 10, 2010

The SEC Speaks Out

Well , we got our answer from the SEC. today.

Chairman Mary Shapiro  answered the Journal in a letter to the editor. It seems that  the SEC doesn’t want the NRSROs to be the end-all for credit measurements. They are “seeking to reduce an undue reliance on the ratings” and that money managers do their own independent credit quality  analysis. The NRSRO rating should  just be a baseline measurement, a minimum level, or as she describes, a floor.

Shouldn’t the SEC stay out of this?

If you invest in anything, you should bear the risk. If there is fraud or mismanagement, the SEC. licensing and regulatory surveillance functions will find it. EC opinion on NRSRO credit evaluations puts them, and the U.S.  back in the endorsement business.

We will end up back in the same money market crisis again. We need to get out of the taxpayers-backstopping-investors cycle.  If you invest in a money market fund, you should earn the money market rate. Its up to you to decide if you want to take the risk

On her second point, I applaud Chairman Shapiro for clarifying the “floating NAV” proposal, and their investigation of its utility.

SEC is On the Job With Ratings and NAV Proposal – Wall Street Journal, February 4, 2010

It’s Time For Independence

The ratings agencies’ primary role is to serve as an independent and completely neutral evaluator of an investment’s risk. In the simplest sense, the agencies are the referees at the basketball game. And like the referees, their responsibility is to assure an honest and clean game for the thousands who have plunked down some hard earned cash and have “invested” in watching a game.

There are dozens of proposals being floated that are all meant to arrive at this independence without fundamentally changing the business model that has rating agencies being paid by the securities’ issuers. Possibly the most startling is a proposal to hold all ratings agencies jointly liable whenever any of them violate securities law—an effort to have them all police each other. It isn’t difficult to foresee the chaos—and litigation—that would quickly ensue.

Until you reverse the flow of money, until money flows from investors to the agencies — until the crowd or an independent third party pays the referees instead of the players — there can be no real confidence that this conflict of interest has been extinguished..

What’s in the House Financial Services Reform Bill?

“Addresses the immense reliance on ratings by federal regulators and users of ratings

• The bill removes all references to credit ratings in federal statutes under the jurisdiction of the Committee on Financial Services. The bill directs the agencies to devise a standard of creditworthiness to serve as a substitute for ratings in rules and regulations.”

Read it all here - ratings are discussed on pages 1034-1078.

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