Thursday, October 29, 2009

Credit Ratings Now Optional, Firms Find

Posted in the Wall Street Journal by Liz Rappaport and Serena Ng:

The last few months have seen a handful of prominent companies selling bonds or structuring complex securities without credit ratings. They include money manager Highland Capital Management LP, European drinks makers Heineken NV and Gruppo Campari, and the global bank Credit Suisse Group AG.

"Two years ago, deals like this would have been inconceivable," said Peter Sack, who runs Credit Suisse's mortgage-backed securities structuring group. "Now they are a viable option."

[credit ratings]

While small in scope so far, the deals indicate that credit ratings from major firms like Moody's Investors Service and Standard & Poor's aren't a necessary ingredient for successful bond sales. The raters' alphabetical risk assessments have been ubiquitous in credit markets for decades. And, even though policy makers and regulators criticized the ratings firms for failing to foresee risks in the markets that led to trillions in losses, they have yet to propose a viable alternative to the current system.

"The ratings process is still undergoing changes, but the market needs to move forward and people are finding ways to do so," says Stephan Kuppenheimer, chief executive of FSI Capital, a New York money manager.

Dallas-based Highland Capital is putting together three collateralized-loan obligations, deals that will be at least $500 million in size and backed by corporate loans, according to a person familiar with the matter. The deals will be launched in coming months, and one will have no credit ratings at all.

The Highland deal could help resurrect a part of the credit markets that had effectively shut down -- in part because investors feared massive losses due to credit-ratings downgrades. It comes after another unrated "structured" deal this past summer, when Credit Suisse sold about $1 billion of securities backed by mortgages it had bought from a lending unit of American International Group Inc.

This week, Dubai sold $1.25 billion in U.S. dollar bonds and about $681 million in Islamic bonds without credit ratings. The Persian Gulf emirate's economy has been hard hit by downturns in real estate and the financial markets, but its unrated bonds attracted risk-taking investors looking for yield. The Dubai government sold the debt for a yield over 6%, compared with 3.85% yields on comparable debt of neighbor Abu Dhabi, which has a strong credit rating of double-A and recently provided Dubai with financial support.

Speed is driving part of the push toward offerings without ratings firms' rubber stamps. Debt issuers are paying slightly more money to sell unrated deals, but they are likely to get done more quickly. Obtaining a credit rating for a securitization, particularly one that is backed by nonstandard loans, can take several months.

Some U.S. and global-debt issuers may be taking a page out of the playbook of Europe's debt markets, where several well-known companies have for years bypassed ratings.

"Our reputation is good....I don't think a rating would have mattered that much," said Bob Kunze-Concewitz, chief executive of Italy's Gruppo Campari, which in October sold €350 million ($515 million) in seven-year bonds with a 5.375% interest rate.

Moody's and S&P said in statements that, while they encourage investors to do their own due diligence, their ratings still play an important role in the markets and investors will continue to use them. Moody's said it continues to rate more than 90% of the corporate and financial institution bonds issued globally. S&P said it continues "to work with market participants to restore confidence in the capital markets and the ratings process."

Investors buying unrated debt are doing their own analysis of the collateral and expected cash flows that back the debt. They include hedge funds and other types of institutional investors such as pensions, say people involved in the deals. More deals are in the pipeline, said bankers.

To be sure, selling unrated deals into the markets comes with its own set of potential troubles. Many investors' mandated guidelines are pegged to credit ratings, which provide a common ground when trading securities in the secondary markets. Unrated deals may be hard to sell.

In September, Bank of America Merrill Lynch offered investors the opportunity to buy $239 million of securities backed by subprime mortgages owned by Lone Star Funds without credit ratings. Since its initial offering, parties involved in the deal have sought an investment-grade credit rating in a move that may make it easier for an investor to sell the securities into the secondary market.

Wall Street isn't alone in taking steps to move away from ratings. Insurance regulators are considering an overhaul of the way they calculate insurers' capital requirements to remove ties to credit ratings for some types of securities.

The Securities and Exchange Commission last month voted to amend some securities laws to remove references to credit ratings. The Federal Reserve will soon start performing formal risk assessments on securities that may be financed by one of its key lending programs, the Term Asset Backed Securities Loan Facility.

On Wednesday, a key U.S. House panel approved a credit-ratings bill that would subject rating firms to more regulation and require federal agencies and departments to review their reliance on ratings and consider using other risk measures for debt instruments.

Broadly, the SEC's rule changes are symbolic steps, "and could send a message that investors shouldn't rely excessively on ratings agencies to define quality," says Roger Joseph, a partner at law firm Bingham McCutchen LLP.

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