Thursday, June 5, 2008
New York State Attorney General Andrew M. Cuomo today announced agreement with the nation’s three principal credit rating agencies in the residential mortgage-backed securities market -- Standard & Poor’s (“S&P”) Moody’s Investors Service, Inc. (“Moody’s”), and Fitch, Inc. (“Fitch”) -- designed to increase the independence of the ratings agencies, ensure that crucial loan data is provided to the agencies before they rate loan pools, and increase transparency in the RMBS market.
Under the agreements, the credit rating agencies will fundamentally alter how they are compensated by investment banks for providing ratings on loan pools. In addition, the ratings firms will all now require for the first time that investment banks provide due diligence data on loan pools for review prior to the issuance of ratings. This will ensure that significant data, which was not previously disclosed to the rating agencies, will be received and reviewed by them before any bonds are rated.
Under current practice, credit rating agencies were typically only compensated by investment banks if they were selected by the investment banks to provide an ultimate rating on a loan pool. They were paid no fees during their initial reviews of the loan pools or during their discussions and negotiations with the investment banks about the structuring of the loan pools. Investment banks were thus able to get free previews of RMBS assessments from multiple credit rating agencies, enabling the investment banks to hire the agency that provided the best rating. In addition, the Attorney General’s investigation found that credit rating agencies were not privy to pertinent due diligence information that investment banks had about the mortgages comprising the loan pools.
All three rating agencies have agreed to implement the following reforms:
• Fee Reforms. Credit rating agencies will now establish a fee-for-service structure, where they will be compensated regardless of whether the investment bank ultimately selects them to rate a RMBS.
• Disclosure Reforms. Credit rating agencies will disclose information about all securitizations submitted for their initial review. This will enable investors to determine whether issuers sought, but subsequently decided not to use, ratings from a credit rating agency.
• Loan Originator Review. Credit rating agencies will establish criteria for reviewing individual mortgage lenders (known as originators), as well as the lender’s origination processes. The credit rating agencies will review and evaluate these loan originators and disclose their originator evaluations on their websites.
• Due Diligence Reforms. Credit rating agencies will develop criteria for the due diligence information that is collected by investment banks on the mortgages comprising an RMBS. The credit rating agencies will receive loan level results of due diligence and review those results prior to issuing ratings. The credit rating agencies will also disclose their due diligence criteria on their websites.
• Credit Agency Independence. Credit rating agencies will perform an annual review of their RMBS businesses to identify practices that could compromise their independent ratings. The credit ratings agencies will remediate any practices that they find could compromise independence.
• Representations and Warranties. Credit rating agencies will require a series of representations and warranties from investment banks and other financially responsible parties about the loans underlying the RMBS.