Two recent private residential-mortgage backed securitization platforms came to market last week. JPMorgan and Everbank will both market RMBS deals to investors.
While I don’t view this as a revival of the market, it is interesting what the renewed interest in RMBS is bringing with it: the return of unsolicited ratings. Well, technically, these are unsolicted comments, where a ratings agency declares not what they would rate a deal, but what they would not rate it.
These comments [ratings] occur when a credit rating agency, not asked by the issuer to provide the rating, releases their own take on the given deal. The controversy is that credit rating agencies almost always seem to behave as if they would have assigned lower ratings when not paid by the issuer to do so.
And even these new deals are not immune to the long-time trend.
In its unsolicited ratings report on the JPM deal, Moody’s declared it would not have assigned triple-A ratings. Coverage from the Wall Street Journal cites Moody’s reasoning, with Al Yoon writing that “in addition to the weak reps and warrants, JP Morgan is offloading all of the credit risk of the loans off of their books in the deal.” The agencies that did assign triple-A feel this tail risk is adequately hedged.
Are credit agencies declaring that these deals aren’t worth triple-A out of a genuine concern of lower-than-expected performance? Or are they feeling raw that they didn’t get paid to rate the deal and would’ve provided higher ratings if done so?
If it’s the former, then there’s no problem. If it’s the latter, then the practice should end.
The Securities & Exchange Commission ruling against conflicts of interest, 17g-5, prohibits assigning ratings on the basis of compensation status. All of the major credit ratings agencies are onboard with this rule. But, clearly this doesn’t apply when the rating is unsolicited.
One alternative, used by DBRS, is to not rate the deal at all.
“In two recent instances, DBRS declined to rate transactions containing certain weak reps & warrrants standard,” said the ratings agency. “DBRS believes that such new reps and warrants standard described above has the potential to considerably weaken investors’ ability to demand a repurchase.”
A working paper from the Frankfort School of Finance & Management in 2009 found bank opacity to be the most likely reason behind lower, unsolicited ratings. The paper could not determine definitively that there is a link between lack of compensation and lower unsolicited ratings.
And until someone does, the practice of lower, unsolicited ratings will remain unchecked, and controversial.
