As the US subprime mortgage crisis shows little signs of relenting and few new securitisations are coming to market, the process of identifying what went wrong and how future calamities might be prevented has commenced.The latest initiative comes from rating agency Moody’s, in a call for comment issued on March 26.
The proposals are aimed primarily at originators and issuers, and are designed to expand and improve the quality of data and accountability in the US residential mortgage securitisation process. As Jonathan Polansky, a group managing director at Moody’s asset finance group in New York, put it: “We are proposing that parties' representation and warranties be strengthened to improve data integrity. Representations and warranties exist, but they could be tightened up and that, combined with third-party data reviews, would improve the quality of information in deals and allow us to have greater confidence in the data we receive.”
Aside from calls for stronger representations and warranties, the report proposes an independent pre-securitisation review of underlying mortgage loans, standardised post-securitisation forensic review, expanded loan-level data reporting of the mortgage pool, as well as ongoing loan performance and originator assessments. For issuers that fail to meet the required standards, Moody’s potentially could decline to rate transactions, or not assign its highest ratings. “Before assigning a rating, we evaluate the deals that are brought to us. It is up to market participants to determine how those deals are structured,” said David Teicher, a managing director in Moody’s residential mortgage-backed securities team in New York.
However, Moody’s says it might choose not to assign its highest investment grade ratings to, or might decline to rate, transactions in which the proposed guidelines for data integrity and accuracy are not met, or where there is a lack of certain types of data. “Each deal is reviewed on a case-by-case basis so it’s hard to generalise about the effect on ratings, but we are proposing a series of steps to facilitate the provision of an amount of data of sufficient quality for us to issue an appropriate credit opinion,” added Teicher.
Rating agencies and the methodologies they use have been heavily criticised for failing to predict the scale of losses due to US subprime mortgage loans. However, some analysts say a large part of the blame lies with originators and issuers that have not provided accurate information. “I don’t think we can hold rating agencies responsible for reviewing every single loan in a RMBS pool. It is originators who should carry the burden of providing the right information and data, as opposed to providing data which is nicely presented but not sufficient to make a credit judgement,” said Alexander Batchvarov, head of structured finance research at Merrill Lynch in London.
Nevertheless, he adds it is also the rating agencies’ responsibility to flag these problems. “Rating agencies could be a bit more forthcoming in declining to rate transactions if they receive insufficient information,” said Batchvarov.
Few market participants would dispute that transparency and data quality need to be improved. “For the past two or three years, originators have not had to do anything, now they are going to have to put in some effort,” said a New York-based RMBS analyst at a US investment bank. The analyst added the Moody’s recommendations would be a logical direction for the market to take, given the current lack of transparency and ongoing uncertainty.
“Everyone is working on the common goal to restore confidence in the market and I think originators understand that, respect that and are moving in that direction,” said Polansky at Moody's. The question on who will pay for the increased supervision costs, however, remains unclear. “Whenever transactions are done, there are ways in which the costs of transactions are allocated among the various parties, but, from our vantage point, it is up to the parties to determine how exactly that is going to happen," he said.
Furthermore, while a move towards increased transparency is welcomed, the short-term impact is unlikely to be significant, particularly as new RMBS issuance in the US has effectively dried up. “Had such measures been implemented three or four years ago, we may not have got into this situation in the first place, but, short term, such measures will not help anything,” said the New-York based analyst. “In fact, if this is implemented in the middle of the crisis, it will only make the situation more difficult.”
The idea that more transparent data would have prevented the crisis is also debatable. “No matter how much information an investor has, if she is faced with events that have never happened before and/or to which she has assigned a very low probability, this investor may face a loss. No number of rating agencies, third-party verifiers or amount of information disclosure will resolve this problem,” argued Batchvarov.
Moody’s has called for feedback on its suggestions, which are due by April 11. After these comments have been taken into consideration, Moody’s will decide on a strategy for implementation.
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