Tag Archives: rating agencies

Rating Agency Liability The Wide World Over

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Haar has posted a draft of Civil Liability of Credit Rating Agencies – Regulatory All-or-Nothing Approaches between Immunity and Over-Deterrence. This paper helps to fill in a gap in the literature about potential liability of rating agencies across the globe.  Most attention has been given to lawsuits filed in the US, but the recent landmark case in Australia imposing liability on Standard and Poor’s has reminded us that rating agencies may face liability wherever they may rate.

Haar identifies some cases that may also result in rating agency liabilty:  Wochenüberblick, Betriebsberater (BB) 2010, p. 1482 and Bathurst Regional Council v. Local Government Financial Services Pty Ltd (No. 5) [2012] FCA 1200.

She also references a recent French law that expands liability for rating agencies:   Loi n° 2010-1249 du 22 octobre 2010 de régulation bancaire et financière (available here).  This is in addition to the bill expanding liability that is now being considered by the European Parliament.

She also highlights developments, such as a possible new wave of litigation that may follow from the Australian case in countries where similar products were mis-rated, citing P. Durkin and H. Low, IMF talks of new wave of litigation, Australian Financial Review, November 7, 2012, p. 14.

It would be a great public service if someone maintained a list of cases around the globe involving rating agency litigation.  Any takers?

 

 

S&P Is Optimistic That Residential Mortgage Market Is Rising From Bottom

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S&P’s Outlook Assumptions for the U.S. Residential Mortgage Market

support our view of loss projections on an archetypical mortgage loan pool (see description in section IV). The base-case loss projection of 0.5% for U.S. prime mortgage loan pools, incorporates our current outlook which reflects:

  • Standard & Poor’s current economic outlook, which factors slow growth over the next several years, declining unemployment rates, and a moderate increase in interest rates, as well as our cautiously optimistic view of housing fundamentals, based on price-to-rent and price-to-income ratios.
  • Our view that U.S. housing prices on a national level have seemed to have reached bottom. This view underlies our assumption that only a minor percentage of a prime RMBS pool is susceptible to a market value decline of up to 30% in select local markets experiencing a local economic downturn and accompanying distress sale discounts. (1)

S&P’s archetypal loan is “collateralized by a single-family detached primary residence with a loan-to-value ratio of 75%. For more information on the “archetypical” loan, see paragraph 24 in U.S. RMBS Criteria. Our projections for other types of newly originated products could be lower or higher depending on the characteristics of the loans, relative to the archetypical loan.” (2)

S&P notes that mortgage delinquencies have been flat and even declining.  This outlook may be one more crocus pushing through a frozen but thawing residential market.

Scheindlin Allows More Fraud Claims Against Rating Agencies To Go To Trial

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Judge Scheindlin (SDNY) has ruled that investors can proceed with their fraud claims against the big three rating agencies for giving a top rating to a SIV.  There are no surprises in this opinion as it tracks the reasoning of Judge Scheindlin’s earlier opinion in a related action (Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Inc. (Abu Dhabi I), No. 08 Civ. 7508, WL 3584278 (S.D.N.Y. Aug. 17, 2012).)

loan application fees

I think this quotation from the King County opinion puts the issue nicely:

While ratings are not objectively measurable statements of fact, neither are they mere puffery or unsupportable statements of belief akin to the opinion that one type of cuisine is preferable to another. Ratings should best be understood as fact-based opinions. When a rating agency issues a rating, it is not merely a statement of that agency’s unsupported belief, but rather a statement that the rating agency has analyzed data, conducted an assessment, and reached a fact-based conclusion as to creditworthiness. If a rating agency knowingly issues a rating that is either unsupported by reasoned analysis or without a factual foundation, it is stating a fact-based opinion that it does not believe to be true.41

I subsequently held that the rating agency defendants could “only be liable for fraud if the ratings both misstated the opinions or beliefs held by the Rating Agencies and were false or misleading with respect to the underlying subject matter they address.” To sustain a fraud claim against each rating agency, then, plaintiffs must provide evidence that the rating agency issued a rating that it knew was unsupported by facts or analysis — that the rating agency did the equivalent of issuing a restaurant review despite never having dined at the restaurant. (12-13, footnote omitted)

Judge Scheindlin has now made it clear that rating agencies may face liability for their opinions under certain circumstances.  Time will tell whether the 2nd Circuit (which has favored the rating agencies in other cases) will agree.

I can only find the King County opinion and the Abu Dhabi opinion behind the NYLJ paywall for now.

SEC Staff Report on Rating Agencies Goes Through The Motions

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The SEC staff report required by Dodd Frank section 939F looks like it is just going through the motions.  It is poorly organized and marred by poor analysis.  It is unclear what it is trying to achieve, other than complying with the requirements of 939F.

 

SEC To Focus on Structured Finance Ratings

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A SEC staff study looks at three ways to reform the manner in which ratings are produced for structured finance securities.

The study, required by Dodd-Frank, addresses

(1) The credit rating process for structured finance products and the conflicts of interest associated with the issuer-pay and the subscriber-pay models;

(2) The feasibility of establishing a system in which a public or private utility or a self-regulatory organization (“SRO”) assigns NRSROs to determine the credit ratings for structured finance products, including:

(a) An assessment of potential mechanisms for determining fees for NRSROs for rating structured finance products;
(b) Appropriate methods for paying fees to NRSROs to rate structured finance products;
(c) The extent to which the creation of such a system would be viewed as the creation of moral hazard by the Federal Government; and

(d) Any constitutional or other issues concerning the establishment of such a system;5

(3) The range of metrics that could be used to determine the accuracy of credit ratings for structured finance products;6 and
(4) Alternative means for compensating NRSROs that would create incentives for accurate credit ratings for structured finance products.

 

Disturbing Reminders about Rating Agencies in Brummer’s New Article

Quote

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Some disturbing reminders in The New Politics of Transatlantic Credit Rating Agency Regulation.  Major rating agencies (CRAs)

generally did not verify the information used to determine the creditworthiness of the products they rated. Plus new models for rating subprime mortgages assumed that housing prices would continue to increase and the model did not consider the declining quality of the loans themselves. And even where signs did begin to arise, bonds were rated at specific intervals, and not necessarily in reaction to crisis, effectively preserving the long life of artificially inflated ratings. By giving MBS and CDOs high ratings, CRAs essentially encouraged investment in these products. The impact: “Of all mortgage-backed securities it had rated triple-A in 2006, Moody’s downgraded 73% to junk”. Similarly, 80% of CDOs rated AAA by S&P from 2005-2007 were downgraded below investment grade by 2009. Well over a third ended up defaulting, wrecking havoc on the financial system and causing the downfall of scores of financial institutions, including behemoths AIG and Lehman Brothers.  (13-14, citations omitted)

 

SEC 2012 Report on NRSROs

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This SEC staff report has some interesting findings that relate to asset-backed securitizations.  Highlights include

  • The pie charts on page 6 that indicate the overall market share of NRSROs as well as their share by sector.  It is interesting to see that Fitch does significantly better rating Asset-Backed Securities (20%) than it does overall (13%).
  • “In some structured finance rating files, the Staff found incomplete rating recommendations relating to the final tranches and were unable to ascertain what the committee ultimately approved. In some instances, there was no rationale recorded for why the final rating recommendation deviated from the original.” (14)
  • “The Staff found that [one large] NRSRO placed certain European residential mortgage-backed securities tranches on watch for potential downgrades for over two years and failed to review the watch within the timetable specified in its policies. In doing so, the NRSRO failed to follow its policies and procedures with regard to the use of rating watch status and the timeliness of reviews conducted on the rating watch status. The NRSRO also failed to apply new criteria to these transactions within the time period required by its policies.”  (13)