* Difficult to ignore the risk of sovereign stress
* Regulators should revisit assumptions
By Anna Brunetti
LONDON, May 23 (IFR) - Credit rating agencies have sought to shield their ABS rating logic from criticism that their link to sovereign rankings is hampering the resurgence of the sector and neglecting market performance.
Regulators should revisit their assumptions, such as affording ABS more equitable treatment with other products, rather than putting the blame on agencies as inhibiting ABS, the agencies argued.
“We believe our current rating methodologies are justified, and we don’t think that they are significantly constraining securitization issuance prospects,” S&P said in a paper this week. The agency highlighted other factors that limit ABS markets, such as the broader economic and credit downturn and the regulatory risks that lie ahead.
Members of the European Central Bank have repeatedly pointed to the reliance of ABS ratings on sovereign ratings as a hurdle on the road to redemption of the ABS market.
And further criticism could follow the joint statement issued in April by the Bank of England and the ECB in which they said that “the reliance on ratings by credit rating agencies may lead to unwarranted pro-cyclicality effects”. They said at the time that a more substantive paper would be issued in May, and they called for regulatory relief on securitisation.
But regulators should “be careful in attributing to the credit rating agencies” the role of drivers of investor behaviour, said Gordon Kerr, head of European structured finance research at DBRS. He argued that “it is rather the nature of capital markets to be procylical” and to react to macro risks.
DBRS is the only agency that doesn’t apply a hard sovereign rating cap, believing “each transaction should be looked at in its own merit,” Kerr said. The other three agencies said the cap was justified by the severity of risk that ABS would face in case of country defaults and other major macro country events.
“We believe it is impossible to completely de-link structured finance ratings from the creditworthiness of the relevant sovereign,” Fitch said in a report last month, confirming caps of ABS ratings to a maximum of six notches above the sovereign local currency issuer default rating.
And this view is shared by other raters.
“Apart from credit enhancement, portfolio diversification” and other ABS back-ups, “you can’t possibly immunize structured finance if the sovereign is under stress,” said Neal Shah, managing director of structured finance at Moody‘s.
The cap applied on ABS ratings varies between countries, and is determined by macro factors, counterparty and operational risk analysis in addition to the sovereign ceiling.
According to the Moody’s model, Irish, Spanish and Portuguese ABS are capped at four notches above the respective sovereign ratings - which means at Aa3, A1 and Baa1 respectively.
SUPPORT FOR REMOVING RATING REFERENCE However, the agencies say nothing should prevent regulators moving away from a rating-based assessment for liquidity and capital requirements.
“We have been clear that we support removing references in regulation that might encourage mechanistic reliance on external credit ratings,” said Andrew South, head of European Structured Finance at S&P.
South also said ratings alone cannot address all the elements of the risk that regulators should consider when drafting requirements.
In the paper published on Tuesday, S&P questioned whether lower ratings caused by the financial crisis could be seen as the real culprit of poor ABS issuance. The agency noted that by the end of 2013, it had downgraded 55% of outstanding ABS, a lower proportion than the 65% for financial institutions, and only slightly higher than the 50% of non-financial corporates. The figure for sovereigns was 45%.
The sovereign rating cap also hardly justifies a retrenchment of ABS markets, S&P added.
“While AAA ratings may have been the benchmark in the securitisation market historically, investor sentiment could evolve, recognising that ratings in the AA and A categories, for example, still represent very strong or strong capacity to meet financial commitments,” the agency argued.
In contrast to agencies, which are tasked with credit ratings and pursue a different remit, “there is a debate about whether regulators may want to consider if they really see a big difference between Triple and Double A” when they set out requirements, said Michele Cuneo, senior director in credit policy at Fitch.
Considering how punitive the ABS capital treatment outlined so far would be, “they could investigate whether this is consistent with their objectives”, he said. (Reporting By Anna Brunetti, editing by Anil Mayre)