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MBA: Increase Transparency in Credit Rating Agencies

Sorohan, Mike
The Mortgage Bankers Association, in a
statement submitted this week to a House subcommittee, said it supports efforts to increase transparency among the nation's major credit rating  agencies.

MBA President and CEO John Courson submitted the statement to the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises Committee on Financial Services, which held a hearing Wednesday on the the performance of credit ratings agencies and legislation that would increase oversight and transparency of the agencies.

“Because of the high degree of sensitivity associated with credit ratings, MBA believes rating agencies and their ratings methodologies must be held to exacting standards,” Courson said. “Therefore, MBA endorses efforts to increase transparency; reduce misrepresentations; improve investor access to underlying mortgage pool characteristics and securities’ performance data; and reduce potential conflicts of interest among rating agencies and others in the industry.”

The hearing came as criticism of the major credit ratings agencies—Moody's Investors Service; Standard and Poor's; and Fitch Ratings—has reached a crescendo. Critics of the agencies say that they enjoyed a “cozy” relationship with the companies whose securities they were rating and ignored warning signs that some of these securities were rated using inferior methodologies.

“Poor performance by highly rated securities resulted in substantial investor losses and market turmoil which severely damaged the financial markets,” said Dan Gallagher, co-acting director of the Division of Trading and Markets at the Securities and Exchange Commission, who testified on Wednesday. “As we work to restore the health of the markets, it is vital that we take further steps to improve the integrity and transparency of the ratings process, promote competition among rating agencies, and give investors the appropriate context for evaluating ratings.”

Subcommittee Chairman Paul Kanjorski, D-Pa., has circulated a discussion draft (http://www.house.gov/apps/list/press/financialsvcs_dem/nrsro_005b_092509.pdf) of legislation, tentatively known as the Enhanced Accountability and Transparency in Credit Rating Agencies Act. The bill would amend the Securities Exchange Act of 1934 to increase the oversight and transparency of nationally recognized statistical credit rating agencies.

Courson noted that the under the bill, the SEC would review the extent to which each rating agency follows its own rating methodology, internal controls and due diligence procedures. He said while strongly supporting competent rating agency determinations, MBA has concerns that such a process would be duplicative with existing requirements for rating agency compliance officers to submit annual reports regarding these same issues.

“We believe that the intent of this proposal can be accomplished through enhanced rating method and data disclosure which will allow market participants to access the accuracy of credit ratings and provide the opportunity for other rating agencies to provide alternative ratings,” Courson said. “Moreover, the SEC rating agency evaluation would only address whether the rating agencies were following their prescribed methodologies, internal controls, and procedures and would not assess the accuracy or quality of the ratings models or methodologies themselves. Consequently, the SEC would not have authority to take action on ill-conceived rating models if the rating agency followed its prescribed methodologies, controls, and procedures.”

Additionally, MBA said it supports designation of a compliance officer, who would report directly to rating agencies' boards of directors and would be prohibited from performing ratings; require rating agencies to disclose information about assumptions made during the ratings process, as well as the rating methodology employed; and restrictions on the ability of rating agencies to provide risk management and consulting services to the issue of securities that the agency rates.

However, MBA said it opposes a provision in the draft bill that would require rating agencies to disclose “preliminary ratings.” Ostensibly to prevent “rating shopping,” MBA  noted that in the case of commercial mortgage-backed securities, the pool of loans that receives a preliminary rating is often significantly altered, i.e., new loans are added and some loans that were part of the preliminary rating are taken out of the loan pool) by the time that the CMBS is issued. “Consequently, examining preliminary ratings can be misleading because they may not represent the characteristics of the loan pool once it has been securitized,” MBA said. “Because of these three considerations, MBA does not support the disclosure of preliminary ratings and opposes this provision.”

Additionally, the bill requires rating agencies to adopt rating symbols that distinguish among structured products, non-structured products, corporate offers, municipal offers, and such other products the SEC deems appropriate. The Agencies Act would require the new rating symbol to be attached to all structured securities regardless of their recent or long-term performance. Such a symbol would brand all structured securities as a single asset category, despite the fact that different structured securities exhibit markedly different performance characteristics (e.g. CMBS, RMBS, and securities backed by credit card debt or automotive loans). MBA said it opposed this provision.

“We are concerned that this approach could spawn greater investor confusion because a wide variety of securities would be lumped into an equally broad investment category. The performance of a security is primarily attributable to the performance of its underlying assets, not its structure,” MBA said. “The use of a structured ratings symbol could be perceived as a broad cautionary signal when in fact the underlying assets determine the securitization’s risk parameters. As a consequence, such a symbol would potentially steer investors away from security types that have demonstrated very strong performance records, such as CMBS during the current credit crisis. If enacted, this provision could force institutional investors to modify their lists of permissible investments.”

MBA further noted that the provision would necessitate amendments to federal and state laws, regulations and supervisory guidance in order for them to comport with the new ratings framework. “This provision is also likely to instigate unnecessary short-term disruptions as institutional investors determine how to apply the new ratings framework to their existing holdings,” MBA said. “This, in turn, could further depress liquidity in the market for structured products. An additional concern is that this component of the Agencies Act is redundant with the additional ratings methodology and data disclosure requirements...MBA believes these disclosure requirements obviate the need for a separate ratings symbol. For these reasons, MBA strongly opposes the inclusion of a requirement for such an identifier in this legislation. Such an approach would stigmatize a wide category of securities and create compliance burdens for bond holders.”

Finally, the bill removes reliance on ratings in federal statutes where references to ratings are made. MBA said it supports a more harmonious reliance, on credit ratings, in the various rules and regulations of regulatory agencies in order to create a consistent standard and to avoid regulatory conflict between the different regulatory agencies.

“Unfortunately, this provision would lead to unintended consequences,” MBA said. “For example, state statutes governing insurance companies that include references to ratings would not be impacted. In addition, international risk-based capital conventions to which the United States subscribes, such as Basel II, maintain references to ratings to determine risk-based capital requirements for certain structured securities. Consequently, the removal of reliance on ratings in federal regulations would create a potential conflict with state laws and international conventions. The latter could enable regulatory arbitrage opportunity for multi-national financial institutions. Therefore, MBA recommends that this provision be removed from the legislation.”

Representatives of the ratings agencies acknowledged that some reform is necessary, but warned that legislation should not swing the pendulum so far as to have unintended consequences.

“We welcome reform efforts that are likely to reinforce high quality ratings and improve market transparency without intruding on the independence of rating opinion content,” said Ray McDaniel, chairman and CEO of Moody's. “We believe that some of the reform proposals, such as increasing transparency in the ratings process or reducing the use of credit ratings in regulation, likely will have a positive impact. We remain concerned, however, that other proposed measures, while well-intentioned, do not address the more fundamental vulnerabilities in credit markets and ultimately could, if implemented, reduce transparency and the availability of diverse, independent opinions.”

McDaniel added that policymakers should review weaknesses that exist in the structured finance market, “in particular the need for greater transparency and disclosure by issuers to the investing public of information about transaction structures and asset pools.”