September 04, (LBO) – Standard & Poor’s (S&P) had replaced its president amid mounting criticism by investors and calls by US lawmakers and EU officials to explain lax rating decisions. Standard and Poor’s had named Deven Sharma to replace Kathleen Corbet as president.
McGraw-Hill, the parent company of S&P said Corbet was stepping down “to pursue other opportunities.”
Moody’s Investors Service failed to downgrade asset-backed securities until July when they had lost more than 50 cents to the dollar the Bloomberg newswire said.
US Senate Banking Committee Chairman Christopher Dodd had called on credit rating companies to explain why they had assigned top investment grade ratings to securities that said yesterday “never deserved them.”
Global markets have been in turmoil since many securities backed by defaulting US mortgages were discounted in debt markets to reflect their newly discovered ‘risky’ status.
Asset-backed securities are able to get higher ratings than their issuer through various credit enhancements techniques, including over-collateralization (putting more assets than needed to pay off the interest and principle) and cherry picking better borrowers.
The loans are then packaged ‘or securitized’ and sold off to new buyers for cash. The assets are then no longer in the books of the original issuer and are considered ‘off balance sheet’ because they have been sold to special companies set up for the purpose.
Somewhat similar techniques were used to hide liabilities of companies such as Enron.
With rising US interest rates, many poorer home-owners who got floating rate housing loans or adjustable rate mortgage loans (ARM’s) were now defaulting as they could no longer afford their installments.
With defaults in the underlying mortgages, the credit quality of the asset backed securities themselves fell.
Credit-rating companies may be successfully sued by investors who have lost money on subprime-mortgage securities and other similar bonds, a study by Rosner and Joseph Mason, an associate finance professor at Drexel University in Philadelphia had said.
“If the rating agencies believe this is going to be business as usual, they are very wrong,” an EU official told Britain’s Financial Times newspaper.
“The securitised subprime mortgage market would not have grown to the extent that it did without the favourable ratings given by some agencies.”
The Financial Times said banks first warned about a potential crisis in subprime home loans — high-risk loans to people with poor credit histories — last year, but credit agencies Standard and Poor’s and Moody’s only downgraded ratings this year.
Meanwhile debt markets had now started to discount all types of debt securities, due to fears that risks had been under-estimated.
Standard & Poor’s recently lifted the outlook on Sri Lanka’s sovereign rating from negative to stable, saying the trend of government finances were improving, taking many independent analysts by surprise.
Economic analysts have been watching with rising trepidation as a cash-strapped spendthrift government increasingly dipped into the country’s international reserves and relied on central bank credit to make ends meet.
Fitch, another agency that had rated Sri Lanka said it saw no reason to changes its stance.
“We continue to regard the negative outlook on Sri Lanka’s ratings as appropriate,” said Paul Rawkins, London-based senior director of Fitch’s sovereign team told Bloomberg.
“The security situation remains a cause for concern and the macroeconomic policy environment is not encouraging, particularly in the light of current global financial market turmoil.”
Fitch had however rated Sri Lanka ‘BB-‘, a notch above S & P’s ‘B+’ rating, which are both below the ‘BBB’ investment grade threshold.