Are The Ratings Agencies Really Taking a 'Tough Stance' on Subprime Mortgage Debt?

According to the Wall Street Journal, Moody's (MCO) says it is taking a hit for its tough stance on lending standards:

Moody's Investors Service says it is paying a high price for its tough stance on lax lending standards for commercial mortgage-backed securities.

In a new report that assesses the status of the market, the Moody's Corp. unit said it was passed over and not hired for 75% of the commercial mortgage-backed securities rating assignments issued in the past few months as a result of its requirement that issuers add an extra layer of credit enhancement. Moody's said issuers are "rating shopping" -- meaning they were hiring competitors that would hand out higher ratings on securities. Because Moody's makes money rating ...

Moody's (MCO) taking a tough stance on ratings? For starters, all of the ratings companies have fatally flawed ratings models.

In addition, Moody's admits the following: "Moody's has no obligation to perform, and does not perform, due diligence." As I have said before, truer words were never spoken.

• In Moody's In Wonderland I wrote about Moody's stunning display of twisted logic, whereby they actually made it a blessing to have rising default risk.
• In Mispricing Risk / Conflict of Interest I talked about the obvious conflict of interest between ratings companies and the companies they rate.
• In The Rating Game Scam I commented on a Bloomberg article accusing the S&P and Moody's of masking $200 billion of subprime bond risk.

Original Ratings

In Stress Test I noted that:

Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the S&P ratings criteria that were in place when they were sold, according to data compiled by Bloomberg.

So far the S&P has downgraded less than 2% of of the $565.3 billion of subprime bonds issued from late 2005 through 2006. The initial claim by the S&P was $12 billion but the S&P made a mistake. It was a mere $7 billion.

In Moody's downgrades risky mortgage debt back on April 30th I see Moody's downgraded $348 million of bonds in lower-rated classes. Moody's downgraded $348 million of bonds -- out of a $14.1 pool of subprime debt.

On July 10th I see Moody's Downgrades Residential Mortgage-Backed Securities.

Moody's Investors Service has cut its ratings for 399 residential mortgage-backed securities [RMBS], citing higher-than-expected delinquencies in the underlying loans, the same day that Standard and Poor's said it may start cutting ratings on $12.1 billion of mortgage-related debt.

Moody's has an additional 32 securities under review for possible downgrade. The securities were originated in 2006 and their downgrades would affect a total of $5.2 billion in debt.

Moody's downgraded $5.2 billion in 399 securities and considers reviewing (drumroll please...) another 32 securities.

A google search for "Moody's Downgrade Debt" turns up a couple other small items but no totals were given none of it was it mortgage related that I could see.

In S&P, Moody's to cut rates of risky debt The Political Gateway posts a combined total (Moody's & S&P) debt downgrade at $17 billion ($5 billion and $12 billion respectively).

But on July 13th we see S&P: Whoops! A $5 billion subprime blunder.

Standard & Poor's admitted to making a nearly $5 billion blunder in correcting its own estimate for subprime securities it is reviewing for ratings cuts. S&P corrected the volume of residential mortgage-backed securities it placed under review for downgrade on Tuesday to $7.35 billion from $12.1 billion.

"This is obviously sloppy by S&P," said Mirko Mikelic, a fund manager at Fifth Third Asset Management in Grand Rapids, Michigan. "I don't think anyone's doing back flips."

S&P said the volume corrected represents 1.3 percent of the $565.3 billion U.S. subprime mortgage market it rated between the fourth quarter of 2005 and the fourth quarter of 2006.

So assuming the S&P downgrades all $7.35 billion it is looking at and adding in another $5 billion for Moody's (let's be generous and add $5 billion for Fitch) we have a grand total of $17 billion of downgrades out of a pool of $565 billion of some of the worst mortgage dates to hold. That equals 3% of the total, when according to Bloomberg, almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the S&P ratings criteria that were in place when they were sold.

Of course not all of that debt was subprime. Then again, doesn't that make matters worse? How much of it should have been subprime but was rated as high as AAA by insane rating strategies of CDOs squared and the like. Moody's can't even bring itself to downgrade what nearly everyone on the planet knows is toxic garbage.

So this talk of a "tough stance" by Moody's is unconvincing. Maybe Moody's is losing out on a few deals as issuers shop around. So what? Not playing the ratings game scam is easy to do now with all of these blowups we are seeing. It's much tougher to do what needs to really be done, and that is to downgrade much more debt that it has. Moody's is obviously taking the easy way out on that score. And the fact that so much more debt is deserving of these downgrades shows you just how badly Moody's failed to do the right thing in the first place.

Moody's attempt to play the role of victim is galling given that it has failed, every step from initial ratings to now, to do what needs to be done.

Comments

[Frank Li:]

William Ackman of Pershing Square Capital Management talked about exactly this at the Ira Sohn dinner in May. Here's an excerpt from notes on what he said. The notes were taken in real time, and may contain transcription errors:

<blockquote>
<strong>William Ackman - Pershing Square Capital Management</strong&...

...Ackman highlighted the current liquidity environment while going into detail about the creation of liquidity using the ABS &amp; CDO markets. He highlights the moral hazard created by the fact that all parties are paid upfront, whether it is a mortgage origination on the smallest scale or credit securitization on a large scale.

<ol>
<li>Lesser securitized paper is given higher ratings then the underlying, because of the way ratings agency’s under measure correlation. The have recently made some statements to the effect that they have under measured correlation.</li>...

<li>Highlights the $800 Billion of subprime mortgages due to reset, the 2H of 2007 will be the most active part of this process.</li>

<li>Ackman makes the analogy that the same financial engineering in the subprime market is being used in the LBO market.</li>

<li>Ackman’s assessment of the market is that in recent weeks the liquidity in the CMBS market is drying up. He point to the weakness of REIT equities.</li>

<li>Ratings agencies responsible for theoretically “overseeing” the s structured finance market get near ½ there revenues from structured finance.</li>

<li>Portfolios are marked to model and not to market.</li>

</ol>



<em>Ackman offers a way to play this theory:</em>

<strong>Short-AB... Ambac Financial</strong&g...

<ol>
<li>$18.7 Billion in Subprime exposure is equal to 284.4% of statutory capital.</li>

<li>Leverage is 80.8 to 1 (Face Value Bonds/Statutory Capital)</li>

</ol>




<strong>Short-MB... MBIA</strong>

<ul>
<li>Structured finance has grown from 14% of guarantees in 1996 to 32% of guarantees in 2006</li>

<li>Leverage is 94 to 1 (Face Value Bonds/Statutory Capital)- Makes this comparison to Citigroup which is leveraged at 12 to 1 (Risk Adj. Assets/ Tier 1 Capital)</li>

<li>MBI’s Credit exposure is $635 Billion based upon $6.8 Billion in capital in comparison to Citigroup where Credit exposure is $1,107 Billion based upon$127 Billion of capital.</li>

<li>MBI’s Reserves/ Credit exposure equals 3 basis points in comparison to 96 basis points for Citigroup.</li>

<li>Potential catalyst- FASB is in a comment period about a rule clarification which will force insurers to book revenues as risk exposure mitigates. Currently MBI books approximately 45% of revenue at time of sale.</li>

<li>Significant senior management turnover in the past year. CFO, Chairman of the Board, President of MBIA Insurance, Head of Global Structured Products.</li>

</ul>
</blockquote>

2007 Jul 20 04:56 AM

[Ralph F:]

Bloomberg had v good coverage of this issue on 2007-05-31:



<blockquote class="quote"><b... Boom Masks Subprime Losses, Abetted by S&amp;P, Moody's, Fitch</b>

2007-05-31 00:08 (New York)
By Richard Tomlinson and David Evans

...The three leading rating companies, all based in New York, say that policing CDOs isn't their job. They just offer their educated opinions, says Noel Kirnon, senior managing director at Moody's.

... ``What we're saying is that many people have the tendency to rely on it, and we want to make sure that they don't,'' says Kirnon, whose firm commands 39 percent of the global credit rating market by revenue.

S&amp;P, which controls 40 percent, asks investors in its published CDO ratings not to base any investment decision on its analyses. Fitch, which has 16 percent of the worldwide credit rating field, says its analyses are just opinions and investors shouldn't rely on them.

The rating companies apply their usual disclaimer about the reliability of their analyses to CDOs. S&amp;P says in small print: ``Any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision.''...

...When it comes to CDOs, rating companies actually do much more than evaluate them and give them letter grades. The raters play an integral role in putting the CDOs together in the first place.

Banks and other financial firms typically create CDOs by wrapping together 100 or more bonds and other securities, including debt investments backed by home loans.

Credit rating companies help the financial firms divide the CDOs into sections known as tranches, each of which gets a separate grade, says Charles Calomiris, the Henry Kaufman professor of financial institutions at Columbia University in New York.

Credit raters participate in every level of packaging a CDO, says Calomiris, who has worked as a consultant for Bank of America Corp., Citigroup Inc., UBS AG and other major banks. The rating companies tell CDO assemblers how to squeeze the most profit out of the CDO by maximizing the size of the tranches with the highest ratings, he says.

...``It's important to understand that unlike in the corporate bond market, in the securitization market, the rating agencies run the show,'' he says. ``This is not a passive process of rating corporate debt. This is a financial engineering business.''

Credit raters consult with bankers in determining the makeup of a CDO, and banks make the final decisions, says Gloria Aviotti, Fitch's global head of structured finance...</blockqu...

The entire article is really worth reading:
www.bloomberg.com/apps...

2007 Jul 20 05:24 AM

[Long-Short Guy:]

Related:
<blockquote>
<b>Treasuries Rise Most Since March on Subprime Crisis, Bernanke</b>

Housing is ``the underlying dynamic to the subprime mess,'' said Jay Mueller, who manages about $3 billion of bonds in Milwaukee at Wells Fargo Capital Management. ``That data will receive a lot of scrutiny.''...

S&amp;P lowered 14 ratings on European collateralized debt obligations yesterday after downgrading 75 U.S. CDOs made up of subprime mortgage derivatives on July 19. The European rating actions weren't related to the U.S. cuts, the agency said...
</blockquote>

Source:
www.bloomberg.com/apps...;sid=a3YNeI.RjZ1k

2007 Jul 22 09:38 AM