‘We’re concerned about weakened US subprime bond market’

‘We’re concerned about weakened US subprime bond market’

Mumbai: Global rating agency Standard & Poor’s recently named Deven Sharma to replace Kathleen Corbet as president this month. McGraw-Hill Cos., the parent of S&P, said in a statement that Corbet resigned to spend more time with her family but there was widespread belief among US lawmakers and investors that Corbet had to go for failing to judge the risks of securities backed by subprime mortgages. Mint asked Sharma for an interview but he declined. Mint’s emailed questions were answered by Martin Winn, vice-president, communications, S&P, who strongly defends the agency saying:" What we have witnessed in recent weeks is a broad reassessment and repricing of credit risk by the market, not an upsurge in defaults." According to him, S&P’s credit rating is an opinion about the probability of a security or debt issuer defaulting and it is not investment advice and does not address the market valuation of a bond. In India, Crisil Ltd is a partner of S&P.

Edited excerpts:

Standard & Poor’s got a new boss at a time when the agency has been criticized by investors for failing to judge the risk of securities backed by subprime mortgages. S&P, investors say, failed to downgrade bonds backed by loans to borrowers with poor credit until July. US Senate Banking Committee chairman Christopher Dodd had recently said credit rating companies must explain why they assigned “AAA ratings to securities that never deserved them.’’

It’s important to look at what has actually happened to our AAA ratings. Since 1 July, we have downgraded around 1% of the US subprime first lien mortgage securities that we rate. 85% of the ratings cut were BBB and below—in other words, the weakest quality securities. None were AAA rated.

It’s also important to understand the role of credit enhancement in our structured finance ratings. Credit enhancement helps offset potential losses by providing a security with excess cash flow. To achieve an investment grade rating, therefore, we require a security with a relatively weaker pool of collateral to have a higher level of credit enhancement than a security backed by a stronger collateral pool.

Technically, ratings are mere opinions and are no recommendation for buy or sell of any security. In this context are the criticisms of rating agencies in the aftermath of the subprime debacle fair?

What we have witnessed in recent weeks is a broad reassessment and repricing of credit risk by the market, not an upsurge in defaults. It is the latter, not the former, which our ratings specifically address.

What commentators sometimes overlook is that a Standard & Poor’s credit rating is an opinion about the probability of a security or debt issuer defaulting.

It is not a form of investment advice and does not address the market valuation of a bond. Between 1 July and 24 August, we received reports of only three defaults from about 15,000 current first lien subprime mortgage securities rated by S&P globally. While we expect defaults to rise in the future, we believe our ratings will remain good indicators of relative default risk.

In the last week of August, S&P slashed the ratings on two mortgage-backed securities funds to junk from AAA in one day. Some of the ratings on $3.2 billion of debt issued by funds set up by Solent Capital Partners Llp.in London and Avendis Group in Geneva were cut by as much as 17 levels to CCC. By S&P’s own definitions, the ratings firm’s assessment went from “extremely strong’’ to “currently vulnerable to non-payment.’’ Do we see more such action?

You are referring to two structured investment vehicles, whose ratings have been significantly impacted by the extreme fall in market values of their investments, even when the credit quality of their assets has remained strong. We continue to monitor closely our ratings on this type of vehicle and will take any further rating action that we believe is appropriate.

Are credit rating agencies at arm’s length from firms which avail of their rating services?

Yes. S&P is widely recognised for providing fair, objective and independent rating opinions. The issuer-pays business model is more than 30 years old. It is accepted and valued by the market because it allows us to make our ratings widely available to investors for free.

What’s more, it does not affect how we assign our ratings —our ratings criteria are publicly available, non-negotiable and consistently applied to all our ratings, and we maintain a strict separation between our analytical and commercial activities. Above all, our reputation and integrity are our most valuable assets, which would make it self-defeating for S&P to provide anything other than impartial rating opinions.

Should they be accountable if investment grade securities collapse overnight to junk status?

We are always accountable to the market for our rating opinions. It has always been the case that within a rating category, individual issuers or issues are likely to perform differently. But looked at in aggregate over the long term, the performance of our ratings—as measured by their correlation with defaults—remains very good. Since 1978, the average five-year default rate for investment grade structured securities rated by S&P is less than 1%; for speculative grade securities it is over 15%. By comparison, the five-year default rates for investment grade corporate issues is 1.3% and 20.5% for speculative grade corporate issuers.

Can the investors expect that rating agencies should anticipate changes in creditworthiness of firms and change their ratings accordingly? Traditionally, we find rating agencies reacting to developments.

Yes, our ratings are forwardlooking opinions about creditworthiness. In the case of US subprime, we have been expressing our concerns about the weakened subprime bond market for the past two years and taking action in anticipation of future mortgage losses. That has included adjusting our criteria and assumptions, downgrading ratings when appropriate, and publicly comments on the risks associated with these securities. To achieve objectivity, we base our analysis on hard facts.

In the instance of US subprime, we undertook appropriate rating action as soon as we got the data about the sharp rise of delinquencies beyond our expected levels.

That said, an important reason why our ratings are valued by the market is their relative stability—unlike market prices, they do not fluctuate on the basis of day to day sentiment. When we make rating changes, we do so on the basis of demonstrable facts, not the ebb and flow of market sentiment.

Finally, tell us about your plans for India. It’s a huge market and Crisil, the S&P outfit, seems to be doing well.

India is a very important market for S&P. Our partner Crisil is doing well on the back of the impeccable credibility established by it and the enormous opportunities that are opening up. The growth in demand for its ratings, research, advisory and analytical outsourcing services is enabling Crisil’s growth.

Standard & Poor’s believes that the Indian markets will continue to benefit from their ongoing modernization and globalization. Standard & Poor’s is well placed, by working closely with Crisil in addressing the needs of this market. While Crisil is well positioned to serve the growing needs of the market on the national front, there is also likely to be a set of new needs as India begins to explore global investment opportunities and its markets grow in size.

Standard &Poor’s is the world’s foremost provider of global data, research and investment advisory services, which will be particularly relevant to the globalizing markets here—we are bringing in sophisticated products to the region, including high-value data and information about investment risks and opportunities.

These include Standard & Poor’s offerings such as Capital IQ, Vista Research, Corporate Equity Research STARS, global credit ratings, international bank loan ratings, structured finance ratings and project finance ratings.