Monday, April 9, 2012

Disagreement between Rating Agencies highlights need for ultra transparency

A Financial Times article looks at how the Rating Agencies are trying to win back investor trust in their ratings by critiquing the structured finance ratings of the other agencies.  They are able to do this because new regulations require that all Rating Agencies be given access to the data on the underlying assets.

The behavior of the Rating Agencies confirms that if ultra transparency into the underlying assets were provided for every structured finance security, market participants would use it.

The behavior of the Rating Agencies also confirms that eliminating the barrier to the data on the underlying assets allows additional experts to express their opinion on the quality of the deal.  Think of all the experts who don't work for the Rating Agencies that could express their opinion if the data on the underlying assets were freely available.

In short, the Rating Agencies show why investors are better off if each structured finance security is required to disclose the current performance of its underlying assets on an observable event basis.  Where an observable event includes, but is not limited to, a payment, delinquency, default or modification.

Credit rating agencies are sparring in public over new ratings as they seek to enhance reputations damaged during the financial crisis. 
Rating agencies were criticized for giving triple-A ratings to complex securities backed by risky mortgage debts that later fell in value. Since then, they have tried to improve their criteria, and the Securities and Exchange Commission has required that arrangers of structured finance deals make information available to the agencies, even if they have not been hired to rate the transactions.
It is only with access to information that the Rating Agencies can assess and rate the transactions that they have not been hired to rate. This was only made possible by the SEC partially lifting the opacity that surrounds structured finance transactions.
One byproduct of these efforts has been a tendency for rating agencies to disagree in public about the creditworthiness of complex securities. 
The latest example came this month when a near-$800 million bond deal backed by U.S. prime mortgages was sold to investors with triple-A ratings — provided by Standard & Poor’s and DBRS, a smaller competitor based in Canada — on some tranches. 
Fitch Ratings issued a statement saying it would not have rated the bonds triple A. 
It said it provided “feedback” on the transaction to the arranger, Credit Suisse , and “was ultimately not asked to rate the deal due to the agency’s more conservative credit stance”. 
Steven Vames, a Credit Suisse spokesman, said it was common for an issuer to engage multiple rating agencies to look at a deal and ultimately choose a subset of those agencies to rate it.
Otherwise known as ratings shopping.

But, with the disclosure of data, the Rating Agencies that were not selected have decided to express their opinion of the deal.
 In March,Moody’s said: “Some recent cases have come to market for which we believe increased risk has not been adequately mitigated for the level of ratings assigned by another agency.”
In particular, Moody’s faulted ratings issued by S&P, Fitch and DBRS on asset-backed deals. 
One portfolio manager who invests in asset-backed securities said: “It is good to have dialogue [among the rating agencies]. 
“Rating agency analysts know they will be scrutinized,” the investor added. “To the extent that [the dialogue] continues, it lets a lot of investors have a broader perspective.” 
Grace Osborne, head of mortgage-backed ratings at S&P, said: “Each of the credit rating agencies has their particular view on credit risk and they want to make sure the market understands that view and how [it is] different from the others. 
“It only helps to highlight where there is a divergence of opinion,” she added. “Knowing where [one agency] is seeing something where another didn’t is only an advantage to an investor in a marketplace.” 
Claire Robinson, a managing director in the structured finance business at Moody’s, said: “Post-financial crisis, the environment has changed. The market has been clear about the desire for diversity of opinion, and investors want more information.” 
Please re-read Ms. Robinson's comment as this is exactly why structured finance securities must be required to provide ultra transparency.

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