Monday, June 8, 2009

Fed’s TALF Fuels Rating ‘Shopping,’ Moody’s Says

Posted on Bloomberg by Caroline Salas:

The Federal Reserve’s Term Asset- Backed Securities Loan Facility is causing issuers to “shop” for credit-ratings, or seek the highest ratings with the lowest standards, according to Moody’s Corp.

The need to have a [single] AAA rating to be eligible “for government programs raises the specter of rating shopping,” Andrew Kimball, head of the global structured finance business at Moody’s Investors Service, said during the company’s investor day today. “Those programs don’t differentiate on the quality of the rating. Rating shopping becomes a problem.”

As a result, New York-based Moody’s hasn’t been included in some recent transactions, Kimball said on a conference call broadcast from the event. Under TALF, the Fed provides low-cost loans to investors to buy AAA rated securities backed by auto, credit card, equipment, education and other kinds of loans. Companies sold about $15 billion of eligible asset-backed debt ahead of the fourth deadline for the Fed’s TALF on June 2, up from about $13.5 billion in May, according to Bloomberg data.

Members of the U.S. Congress and regulators have criticized Moody’s, whose founder John Moody created credit ratings in 1909, along with rivals Standard & Poor’s and Fitch Ratings for ignoring conflicts of interest and risks that helped fuel the worst financial crisis since the Great Depression. The U.S. Securities and Exchange Commission is considering how to improve its oversight of the raters.

‘Creates a Market’

“We are looking in particular at the rating-shopping phenomenon,” SEC Chairman Mary Schapiro said this week before a U.S. Senate appropriations subcommittee. The SEC is considering removing “references to ratings in SEC rules, which creates a market for rating agencies and gives a certain amount of credibility that perhaps they don’t always deserve,” she said.

Credit-ratings companies have changed some business practices in an attempt to eliminate shopping for top ratings, such as agreeing to charge debt underwriters for their preliminary work reviewing the structure of asset-backed securities even if they aren’t selected to grade the bonds.

The Fed mandated that securities must be rated by two or more “major” nationally recognized statistical ratings organizations, or NRSROs, to be eligible for TALF to minimize risk. The Fed may revise how it uses ratings, Chairman Ben S. Bernanke said in an April 13 letter in response to a complaint from Connecticut Attorney General Richard Blumenthal that the central bank’s rules unfairly favor the companies that helped cause the financial crisis.

‘Improved Conditions’

The Obama administration and Bernanke are counting on the TALF as a cornerstone of plans to revive credit and end the recession. While the program is on pace to fall short of its $1 trillion official ceiling, Bernanke said in a letter to a lawmaker last month that the TALF has helped create “improved conditions” in the asset-backed securities market.

Cabela’s Inc., a Sidney, Nebraska-based chain that specializes in hunting and fishing gear, sold about $425 million in bonds backed by payments on its store card for TALF in April. The securities had AAA ratings from S&P, Fitch, and Toronto- based Dominion Bond Rating Service Ltd. Moody’s doesn’t grade the debt.

“The most conservative rating agency usually has the lowest market share, and in the case of TALF-eligible ABS, that would be Fitch,” said Kevin Duignan, spokesman for Fitch in New York.

‘Fact of Life’

“It is the internal mandate to maintain market share that leads an analyst to compromise credit quality,” said Jack Toliver, managing director of global commercial mortgage-backed securities at Dominion.

“More players increase the opportunity for the issuers to play each agency against the others,” he said. “This is a fact of life and prevalent whether there are three or five or 10. Where this becomes a problem is when the major market share leaders build their business plans around maintaining an 80 percent or 90 percent market share.”

“In structured finance we have a very concentrated investor base, my colleagues characterize it as a single investor base in the form of the government,” Moody’s Chief Executive Officer Raymond McDaniel said at the company’s event. “To the extent they are not making active choices on a transaction-by-transaction basis, but are simply saying a AAA is a qualification standard for participation in the program that does encourage rating shopping.”

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