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