Securitization Risk Rising as Standards Ease, Moody’s Says
The riskiness of new securities backed by assets from car loans to commercial mortgages is rising from the lows seen after Lehman Brothers Holdings Inc.’s 2008 collapse, according to Moody’s Investors Service.
Easing underwriting standards and “untested” issuers and assets are contributing to the trend, along with structural features of transactions that can boost risk, the New York-based ratings firm said today in a report. Greater dangers are likely to follow, analysts Claire Robinson and Joseph Snailer wrote.
Shoddy securitizations helped fuel a lending bubble last decade that sparked the worst U.S. housing slump and global financial crisis since the 1930s. Moody’s and competitor Standard & Poor’s drew criticism after awarding top grades to risky mortgage debt that later experienced record defaults, with the Financial Crisis Inquiry Commission created by lawmakers calling them “key enablers of the financial meltdown.”
The riskiness of new securitizations “is still low and has not approached the level it reached in the early to mid-2000s, much less” 2006 and 2007, the analysts wrote. “However, some recent cases have come to market for which we believe increased risk has not been adequately mitigated for the level of ratings assigned by another agency,” they said.
Moody’s described as “inappropriate” the rankings granted by S&P and DBRS Inc. to a recent subprime auto-debt securitization by a lender bought last year by Blackstone Group LP (BX), according to the report. S&P rated the bonds AA, noting the lender’s relatively short track record as a potential risk factor in a report. DBRS offered its top AAA grade.
The lender, Exeter Finance Corp., “is small and unrated, with limited experience and little asset-performance history,” the Moody’s analysts wrote. That creates the “potential for volatility in asset performance,” they said.
Ed Sweeney, an S&P spokesman, said, “The market benefits from a diversity of opinions on credit risk.”
Meredith Fletcher, a spokeswoman for Exeter, and Catherine Chiarot, a spokeswoman for DBRS, declined to comment.
Risk in securitization markets is rising after “tightened lending criteria contributed to a dramatic improvement in the performance of securitized assets in many sectors” as new deals followed the credit crisis, Moody’s said.
Credit-card delinquencies, for instance, reached an all- time low 2.9 percent in December, the firm said. In commercial- mortgage bonds, the size of loans to estimated property values last year rose to about “mid-90” percent, from “the mid-80s” early in 2010, still down from a peak of more than 110 percent before the crisis, according to the report.
“A sign that asset credit quality will continue to loosen in the subprime auto and mortgage sectors is the influx of non- traditional private capital into mostly subprime consumer lenders that will tap the securitization market,” Moody’s said.
Kara Findlay, a spokeswoman for Perella Weinberg, declined to comment. Gordon Runte, a spokesman for Fortress, and Brian Beades, a spokesman for BlackRock, didn’t immediately return messages seeking comment.
Ratings firms have stepped up their criticism of rivals’ grades after the financial crisis, while lenders including Lewis Ranieri’s Shellpoint Partners LLC say the rankers are being too conservative, crimping credit and harming the U.S. recovery.
S&P said that it saw risks in “jumbo” home-loan bonds given top grades in 2010 by Moody’s. Fitch Ratings criticized a mortgage-servicing deal ranked by S&P and DBRS last year.
While Moody’s has refused to rate certain deals, it’s been gaining structured-finance business at the expense of S&P. Last year, Moody’s share of the market was greater for the first time since 1997, according to newsletter Asset-Backed Alert. Moody’s rated 70 percent of securitizations, while S&P graded 62 percent.
“Increased risk in securitizations in and of itself is not troubling,” Moody’s said in the report. “In many instances, credit enhancement or other structural mechanisms can counterbalance increased risks and support the high credit ratings securitization sponsors desire.”
Credit enhancement refers to investor protection such as some bonds tied to pools of loans being paid before others, or reserve accounts with extra cash.
Structural features that are boosting risk include the return of prefunding in the subprime auto-bond market, in which issuers raise cash from bond investors and later buy the assets that will serve as collateral, Moody’s said.
Some of the loosening of underwriting hasn’t yet reached the securitization market, as U.S. home lenders begin to again accept non-prime borrowers, loans to foreigners and alternative forms of income documentation, Moody’s said.
Credit-card companies are also relaxing underwriting standards, with mailings soliciting new customers doubling last year from 2010, Moody’s said. These “lower-quality” accounts have not affected asset-backed deals because they haven’t been securitized, though they may be in the future, the firm said.
Issuers including Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc., American Express Co. and Discover Financial Services were forced to take steps including removing poorly performing accounts from pools to thwart ratings cuts and strengthen credit-card bonds as delinquencies surged in 2009.
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