ratings agencies

Would you have predicted this?

This paper investigates the impact of credit rating changes on the sovereign spreads in the European Union and investigates the macro and financial factors that account for the time varying effects of a given credit rating change. We find that changes of ratings are informative, economically important and highly statistically significant in panel models even after controlling for a host of domestic and global fundamental factors and investigating various functional forms, time and country groupings and dynamic structures. Dynamic panel model estimates indicate that a credit rating upgrade decreases CDS spreads by about 45 basis points, on average, for EU countries.

I would not have! Perhaps I am biased from living in a country where credit ratings are a contrary indicator of sovereign interest rates, and where municipal defaults inevitably lead to helpful comments from ratings agencies like “If the payment doesn’t get made, we would downgrade the rating.” Apparently, though, sovereign ratings matter, at least in Europe and at least at some points on the ratings scale.1 Read more »

You don’t have to agree with everything the SEC does to respect the way they do it: passive-aggressively. Felix Salmon this morning discussed “the problematic JOBS Act, where the SEC has done a good job of stalling on various silly yet Congressionally-mandated reforms,” and the SEC’s similar strategy of “being sensible and dragging its feet” on Congressional dedecimalization proposals. If you’re a regulatory agency tasked by Congress with implementing a new law, and you don’t feel like it, the best approach is always to commission a study.

Is that what’s going on with ratings agency reform proposals?

The 2010 Dodd-Frank financial-overhaul law requires the SEC to create a board that would assign a rating firm to evaluate structured-finance deals or come up with another option to eliminate the conflicts that could arise when debt issuers pay rating firms to rate their bonds. … Sen. Al Franken (D., Minn.) proposed the legislation, which is known as the Franken Amendment.

… Mr. Franken defended his proposal Tuesday to attendees at the round table, including SEC commissioners and SEC Chairman Mary Jo White. He also called on the agency to make changes to the credit-rating industry.

“My plea today is that you take action,” Mr. Franken said. “Millions of Americans lost their jobs because the credit rating agencies didn’t do their jobs,” he said.1

The agency published a report in December – six months late – that was widely expected to announce regulatory changes. Instead, the report proposed more discussion and the convening of a round table.

So hahahaha SEC you suck but the problem seems genuinely hard doesn’t it? Read more »

Bloomberg has a delightful story today about a new JPMorgan RMBS transaction, its first non-agency deal since the crisis. Specifically about this:

The bonds are made riskier by the New York-based bank and other originators of the mortgages offering weaker promises to repurchase misrepresented loans than those on similar deals, Fitch Ratings said today in an e-mailed report. Lenders and bond sponsors have been seeking to trim potential liabilities in such deals as the market revives after suffering billions of dollars of losses from debt sold before the collapse in home prices.

The value of the so-called representations and warranties in the JPMorgan transaction is “significantly diluted by qualifying and conditional language that substantially reduces lender loan breach liability and the inclusion of sunsets for a number of provisions including fraud,” New York-based Fitch analysts including Roelof Slump wrote in the presale report.

So naturally the deal is limited to an Aa rating, as it would be at Moody’s based on those sort of rep and warranty weaknesses, right? Errr not so much:

The classes of the deal expected to receive top credit ratings carried loss buffers of 7.4 percent as Fitch said it adjusted its analysis to reflect the greater investor dangers created by the weaker contracts, according to the report.

So 92.6% of the deal will be AAA rated at Fitch and Kroll, the other rating agency on the deal. Here’s the cap structure from Kroll’s report: Read more »

Fitch Ratings does not want to find itself in S&P’s shoes. Read more »

  • 04 Feb 2013 at 5:10 PM

Controversial New Theory: S&P Got A Few Ratings Wrong

One day – one day soon – the Justice Department will sue S&P for mis-rating a bunch of CDOs, and when that happens let’s all read the complaint and then meet back here to discuss it, okay? [update!] In the meantime we have S&P’s preemptive denial:

A DOJ lawsuit would be entirely without factual or legal merit. It would disregard the central facts that S&P reviewed the same subprime mortgage data as the rest of the market – including U.S. Government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained – and that every CDO that DOJ has cited to us also independently received the same rating from another rating agency.

I submit to you that this is not a great defense, though it has a certain intuitive appeal. If in fact it turns out that S&P knowingly gave terrible CDOs AAA ratings because they were being bribed by investment banks or whatever, then it doesn’t help them much that Moody’s, say, gave the same CDOs the same AAA ratings with pure hearts and empty minds.1 Intent matters; being evil makes you more liable than does being stupid.

More interesting, though, is the claim that “S&P reviewed the same subprime mortgage data as the rest of the market.” First of all, that’s an almost magically ridiculous statement. (Though, also: true!) S&P’s credit ratings not only had the force of quasi-law in 2007 when they were bopping around misrating CDOs: they still have the force of quasi-law today, and there’s no plan to change that. Basel III regulations rely on ratings-agency ratings all over the place. And yet S&P has no actual advantage over anyone else in deciding what’s a good credit risk.

So why would you rely on S&P to tell you what’s a good credit risk? Read more »

  • 22 Jan 2013 at 4:07 PM

At Long Last Egan-Jones Has Been Brought To Justice

The SEC’s press release touting its triumph over rebel-without-a-cause rating agency Egan-Jones gives just the slightest impression that it was written in embarrassment. A trope of SEC press releases is “[thing we are enforcing] is among the most important things in the whole wide universe”; this is hard to say with a straight face when the defendant is guilty “essentially, of filling out forms wrong,” as Jesse Eisinger put it last year. But two SEC enforcement bigwigs give it their best shot:

“Accuracy and transparency in the registration process are essential to the Commission’s oversight of credit rating agencies,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “EJR and Egan’s misrepresentation of the firm’s actual experience rating issuers of asset-backed and government securities is a serious violation that undercuts the integrity of the SEC’s NRSRO registration process.”

Antonia Chion, Associate Director of the SEC’s Division of Enforcement, added, “Provisions requiring NRSROs to retain certain records and address conflicts of interest are central to the SEC’s oversight of credit rating agencies. EJR’s violations of these provisions were significant and recurring.”

To be clear what happened in the Egan-Jones case was, as we’ve discussed before:

  • In 2008, Egan-Jones told the SEC “we have issued 200 ratings and they are on the internet.”
  • A few months later, Egan-Jones corrected the number of ABS and muni ratings from 200 to 23.
  • The correct number was actually zero, as you could tell by looking at E-J’s website.
  • Four years later, the SEC noticed.

“‘Accuracy and transparency in the registration process are essential to the Commission’s oversight of credit rating agencies,’ said Robert Khuzami, Director of the SEC’s Division of Enforcement,” though not so essential that the SEC would get around to noticing admitted inaccuracy inside of four years.

So, I mean: don’t fill out forms wrong! Read more »

It’s popular to say that financial markets and regulators have extremely short memories and so let’s say it about these new Basel liquidity coverage ratio rule changes out today. But not in an annoying sneery way. I mean, in an annoying sneery way, but not the obvious one.

The story is that among the post-2008 Basel mechanisms for keeping banks out of trouble is the required “liquidity coverage ratio,” which for each regulated bank:

  • tots up how much cash is likely to go out the bank’s doors in a crisis due to things like customers withdrawing deposits, derivatives counterparties terminating trades or demanding more collateral, corporate clients drawing down lines of credit, etc.; and
  • requires the bank to hold liquid assets that it could sell quickly in a crisis to meet those demands on cash.1

Virtually everything there is a term of art, but “crisis” and “liquid assets” are particularly squishy. When the LCR was first proposed it had rather harsh ideas of what sort of crisis might affect liquidity, and a rather narrow conception of what assets might be liquid enough to be sold quickly and economically in a crisis. The news today is that Basel has relaxed that approach in a number of specific ways described here and listed here; the brief version is that the types of assets that can be counted toward “high quality liquid assets” has been dramatically expanded to include a lot of corporate and RMBS debt, the assumed outflows in a crisis have been reduced, and the LCR is now being phased in from 2015-2019 instead of going into effect all at once in 2015.

A lot of people think this is a good thing, as it will reduce the already significant demands on “safe assets” and make banks a little more willing to use balance sheet to lend and stuff. As is true of everything that banks like, you can also if you are so inclined easily find people who think it’s a bad thing. There is no particularly Platonic right answer. Basically the exercise here is (1) imagine a bad situation and (2) see if the bank survives your imagined bad situation with a given mix of liquid assets; step (2) is a question of simple arithmetic while step (1) is determined entirely by the direction in which your imagination runs. There are good practical and social reasons for making your bad situation basically “2007-2008, but a little worse,” and so most of the debate is over translating that notion into liquidity outflows and asset haircuts, but if you think that that notion is conceptually suspect I can’t really prove you wrong. If aliens invaded France, SocGen’s liquidity reserve would probably not be suited to the situation.

But whatever. The jarring thing for me was this first bit of the changes to the LCR announced today: Read more »

  • 05 Dec 2012 at 6:03 PM

Greek Bonds Now Defaulted, Also Extra Attractive

You can see why no one likes rating agencies. It’s not exactly a surprise to anyone that Greece’s debt situation is Not Good, so the fact that S&P just downgraded Greece to selective default is (1) not particularly helpful to anyone attempting to make an investment decision re: Greek bonds and (2) not particularly helpful to anyone else either.

That said, I admire S&P’s role as a stickler for the rules of a game that it invented and no one else is playing. Greece is conducting an essentially non-coercive exchange for its bonds at above their all-time high prices. Is that a “default”? Well, for what purposes? Legally, mostly no. For CDS, no. But for S&P, yes. (Yes, it is.) They’re paying off their debt for less than par, so default it is. And since those are the rules, S&P must pointlessly note that Greece is in selective default.1

Nobody else seems to care much. What do you make of this? Read more »