Credit rating agencies only game in town

When a Federal Appeals Court ruled that credit agencies weren’t responsible for overrating mortgage backed securities, I knew this somehow was a game changer.  Why?  Because no one can solely rely on rating agencies to assess risk.

I was reminded of this in a recent story in the New York Times by Gretchen Morgenson titled "The Stone Unturned: Credit Ratings".  Ms. Morgenson states:

It’s the one question about the 2008 financial crisis that people still ask me more than any other: Why have regulators done so little to rein in the credit rating agencies? Other institutions that contributed to the mortgage debacle have submitted to new rules and compliance requirements, but Moody’s Investors Service and Standard & Poor’s and their peers remained relatively untouched.

The status quo is especially baffling because the Dodd-Frank financial reform law actually directed the Securities and Exchange Commission to regulate these firms more closely. So why have they been left to operate pretty much as in the past?

Think about what this means.  This is all happening as the Regulators are tightening what assets Banks can hold and Investors are trying to invest in trade receivables and trade finance structures.

The reality is Rating Agencies are not highly valued or insightful, but they are still VERY important. Given trade finance asset structures are not rated, or the cost of rating a trade portfolio is prohibitively expensive (or next to impossible given the Rating agencies requirements for business cycle data), it seems likely we will continue to see non rated structures pushed out to investors in a private placement manner.

Pre 2008 financial crisis, both Citibank and Standard Chartered developed synthetic note structures (Sealane and CAB). Sealane was a hybrid CLO/ABS structure. Sealane US$ 3 billion portfolio comprised 1,600 customers in 30 countries across Standard Chartered’s core markets. All the assets were sourced from the bank’s balance sheet and included trade finance assets such as Letter of credit, standbys, documentary collections, and other short term trade notes. Given the changes in the credit and capital markets since then, things have changed immensely.

Better sharpen those pencils and dig through the 150 page prospectus to make sure you understand risk versus rewards.  We can’t just rely on Fitch or S&P to do our homework.

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