Apples and Oranges

Sept 25, 2007 (LBO) – The International Monetary Fund which has warned of further fallouts from the sub-prime crisis has called on credit evaluators to use a new rating scale to describe default risks of asset-backed securities. Now asset-backed debt products or securitized instruments use the same rating scale that is used from straightforward bonds of a single issuer.

An asset backed security (ABS) is made by bundling up loans or mortgages issued to many borrowers, separating them from the originating company and re-selling them to investors.

The credit quality of such securities is ‘enhanced’ using a variety of techniques so that they can usually earn a rating higher than the issuer.

Hidden Risks

But the IMF in its Global Financial Stability Report issued on Sept 24 says rating agencies have under-estimated the credit risks and such securities which tend to be illiquid also have significant unrecognized market risks when a holder tries to sell.

IMF said securities backed by sub-prime mortgages and collateralized debt obligations (CDO) backed by corporate debt securities had been downgraded two or three notches at a time by rating agencies.

Usually it was from BBB (in the investment grade