Tag Archives: rating

Getting CAMELS Past Regulators

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photo by Max Pixel

Bloomberg BNA Banking Daily quoted me in Court Asked to Second-Guess Bank Capital, Earnings, Risk Ratings (behind a paywall). It reads, in part,

A now-shuttered Chicago bank is taking on the proverbial giant in a fight to give banks the right to challenge safety and soundness ratings by federal regulators.
Builders Bank, an Illinois-chartered community bank that technically closed its doors in April, wants a federal judge to review a so-called CAMELS rating of 4 it got from the Federal Deposit Insurance Corporation, a rating it said triggered higher costs for insurance premiums (Builders Bank v. Federal Dep. Ins. Corp., N.D. Ill., 15-cv-06033, response 9/13/17). The rating should be reviewed by a court, it said, because it didn’t accurately reflect the bank’s risk profile. A 3 rating would have been more appropriate, it said.
It’s hard to exaggerate the importance of the awkwardly-named CAMELS ratings, which also are used by the Federal Reserve and the Office of the Comptroller of the Currency. The ratings — which measure capital, assets, management, earnings, liquidity, and sensitivity to market risk on a range of 1 to 5, with 1 being the best rating — can mean thumbs-up or thumbs-down on business plans by banks and affiliates.
Want to merge with or buy another bank? Don’t bet on it if your bank has a low CAMELS rating. Want to pay lower premiums for federal deposit insurance? A high rating may mean yes, a low rating probably not. Want to lower your capital costs? Endure fewer examinations? Open new branches? Hold on to a profitable business unit or face regulatory demands to divest it? All of those business decisions and others can turn on how well a bank scores under the CAMELS system.
Pinchus D. Raice, a partner with Pryor Cashman LLP in New York who represents the New York League of Independent Bankers, said judges should be able to look over those rating decisions.
Judicial review would enhance the integrity of bank examinations, he said. “I think it would increase confidence in the process,” Raice told Bloomberg BNA. “Somebody should be looking over the shoulders of the agency, because CAMELS ratings are critical to the life of an institution.” The New York trade group has filed a brief in the suit urging the court to rule against the FDIC.
FDIC Rating Challenged
The FDIC has asked Judge Sharon J. Coleman of the U.S. District Court for the Northern District of Illinois to dismiss the case on several grounds.
For one, the FDIC said, Builders Bank no longer exists. It voluntarily dissolved itself earlier this year and in April transferred its assets to Builders NAB LLC, a nonbank limited liability company in Evanston, Ill., that couldn’t be reached for comment. In a Sept. 13 filing, the bank said Illinois law allows it to continue the suit even though it’s now merged with the LCC, and that it’s seeking damages in the amount of the excessive deposit insurance premiums it says were paid.
Bank Groups Join
The next likely step is a ruling on the FDIC’s motion to dismiss, though it’s not clear when the court might make a decision. Meanwhile, the case has attracted briefs from several banking groups — a joint brief filed in August by the Clearing House Association, the American Bankers Association, and the Independent Community Bankers of America, and a separate brief a few weeks later by the New York League of Independent Bankers.
None of the four groups is wading into the actual dispute between Builders Bank and the FDIC, and their briefs explicitly said they’re not supporting either party. However, all four groups urged the court not to issue a sweeping decision that says CAMELS ratings are exempt from outside review.
According to the Clearing House, the ABA, and the ICBA, banks should be able to seek judicial review in exceptional cases “where such review is necessary and appropriate,” such as if regulators get their calculations wrong, or if regulators use ratings to retaliate against banks that criticize FDIC policies or personnel.
“At a minimum, given the complexity of the CAMELS rating system and the consequences of CAMELS ratings, this court should not issue a ruling that is broader than necessary to decide this dispute and that may undermine the ability of other banks to obtain judicial review,” the brief said.
*     *      *
David Reiss, professor of finance law at Brooklyn Law School in Brooklyn, N.Y., called the case a signal that the banking industry believes a range of agency actions might be held to be unreviewable. “As a general philosophy, unless Congress has made unreviewability crystal clear, I think we want to be careful,” Reiss told Bloomberg BNA. “This does seem intuitively overbroad to me.”
He also said the case, because it involves a bank that no longer exists, raises the possibility of a result that might not be welcomed by the banking industry. “The bank groups may be somewhat worried that a now-dissolved bank may get a court ruling that could have unintended consequences for banks still doing business,” he said.

S&P on Rating Mortgage-Backed Securities Before The Crisis

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S&P has posted The Role of Credit Rating Agencies in The Financial System, remarks by its president at the United Nations. The remarks reflect S&P’s narrative of the events leading up to the Subprime Crisis. This narrative is, unsurprisingly, self-serving but revealing nonetheless.

  • We, like others, did not anticipate the U.S. housing downturn, which led to the financial crisis. But with the exception of our ratings on U.S. mortgage-related securities, our ratings have performed as expected. (3) 

Seems like a perfect example of the exception swallowing the rule . . ..

  • In September of 2008, we were all in the depths of the financial crisis. During that time the vast majority of the securities S&P rated performed as we anticipated, including many structured finance ratings. But the performance of our ratings of certain U.S. residential mortgage-related securities was a major disappointment. Like nearly every other market participant, analyst and interested government entity, we did not anticipate the U.S. housing collapse and its effect on the economy as a whole. (4)

As I have said before, this is self-serving revisionism, when S&P’s own analysts predicted the collapse of many of the mortgage-backed securities that they rated before the Bust.

  • We have taken significant actions to further strengthen our independence from issuer influence. We have long had policies to manage potential conflicts of interest such as a separation of analytic and commercial activities, a ban on analysts from participating in fee negotiations, and de-linking analyst compensation from the volume of securities they rate or the type of ratings they assign. After the crisis, we decided to strengthen analytical independence by rotating the analysts assigned to a particular issuer and enhancing analyst training. (4)

No mention here of the fact that their longstanding policies appeared to have not been up to the task of controlling for conflicts as far as anyone was concerned . . ..

  • For mortgage-related securities, for example, we significantly increased the credit enhancement required to achieve a ‘AAA’ rating and made it more difficult for securities to achieve high ratings. (4)

Thank goodness for that! Time will tell if these new assumptions adequately reflect the risk of default for complex MBS.

MBS Representations Regarding Ratings Based on False Data Are Actionable

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In Capital Ventures International v. UBS Securities LLC et al., No. 11-11937 (D. Mass. July 22, 2013), Judge Casper held that the inclusion of credit ratings based upon “false data” in offering materials for mortgage-backed securities “constitutes an actionable misrepresentation and omission” under the Massachusetts Uniform Securities Act (the relevant provisions of which are substantively similar to those of the Securities Act of 1933). (11) The Court also held that UBS’ “representation that a certain [ratings] process will be used is an actionable statement of fact.” (12)

Capital Ventures had purchased over $100 million of certificates of RMBS that were underwritten by UBS.  The investors in those RMBS “were not given access to the loan files and had to rely upon the representations in the Offering Materials about the quality and nature of the loans that formed the security for their Certificates.” (2) The offering materials stated that the “rating process addresses structural and legal aspects associated with the Offered Certificates, including the nature of the underlying mortgage loans.” (3, emphasis in the original)

Capital Ventures alleged that “UBS knew the ratings were based on false and misleading data such as owner-occupancy and LTV statistics and underwriting quality and thus knew that the ratings were not the product of a process designed to judge the risk presented by the Certificates (as represented in the Offering Materials), but rather reflect the Rating Agencies’ judgment as to the risk presented by a ‘hypothetical security Capital Ventures was promised, but did not receive.'” (3, quoting amended complaint)

The holding in itself is important, but I am curious as to what effect it will have on representations in deals going forward.  Underwriters may very well give investors the opportunity to review the underlying mortgage loans in order to ensure that they are not exposed to this type of liability. Or perhaps the risk is remote enough that they will chance it again.  Time will tell.