U.S. Regulatory Bill May `Flash Freeze' Asset-Backed Market, Industry Says
The U.S. financial-regulation bill may halt the already diminished market for asset-backed securities by increasing liability risk for credit raters, a securitization-industry group and bank analysts said.
The legislation, set for signature by President Barack Obama, eliminates credit-rating companies’ shield from lawsuits when underwriters include their assessments in documents used to sell debt. Moody’s Investors Service and Fitch Ratings have already told Wall Street that because of an increased risk of being sued, they will no longer let underwriters use ratings in bond-registration statements.
The change, if combined with an existing Securities and Exchange Commission rule that restricts sales of asset-backed debt without ratings in offering documents, will put a “flash freeze” on the market, said Tom Deutsch, executive director of the American Securitization Forum. His concerns are shared by analysts at RBS Securities Inc.
“A number of transactions that had been planned for the upcoming weeks have been shelved indefinitely given this proposal,” Deutsch said in an interview yesterday. “The transactions legally cannot go forward.”
Public pension funds have accused Moody’s, Fitch and Standard & Poor’s of helping to fuel the financial crisis by giving top rankings to mortgage bonds that plunged in value when the U.S. housing market collapsed in 2007. Congress scrutinized the firms at hearings and tried to hold them more accountable by making it easier for investors to sue for inaccurate ratings.
The bill overhauling financial regulation subjects ratings companies to so-called expert liability, which means the firms will face the same legal risks as accountants and other parties that participate in bond sales. The potential harm on the asset- backed-debt market is an “unintended consequence” of the legislation, Deutsch said.
“While we will continue to publish credit ratings, given the potential legal consequences, we cannot consent to the inclusion of ratings in prospectuses and registration statements,” New York-based Moody’s said in a July 15 note to clients.
Fitch, also based in New York, said in a statement July 19 that it too would no longer let Wall Street include ratings in offering documents. S&P, a unit of New York-based McGraw Hill Cos., told clients it will “explore mechanisms outside of the registration statement to allow ratings to continue to be disseminated.”
The decision by the ratings firms will make it “difficult or impossible” for Wall Street to sell asset-backed securities tied to residential and commercial mortgages, RBS analysts Paul Jablansky and Brian Lancaster wrote in a report yesterday.
Corporate Bonds Excluded
The SEC could fix the problem by revising rules that force underwriters of asset-backed debt to include ratings in disclosure documents, the analysts wrote. Issuers of corporate bonds don’t have to include ratings.
Wall Street sold $24 billion of mortgage securities in the first half of 2010, and almost all were repackagings of existing bonds, according to newsletter Asset-Backed Alert. That’s down from a record of about $1.2 trillion in both 2005 and 2006.
While issuers of mortgage securities could get around the new legislation and SEC rules by selling unrated bonds, investors wouldn’t buy the debt, Deutsch said.
“Investors that are investing, pension funds and money funds, have strict investor guidelines that say if it doesn’t have a rating you cannot buy it,” he said. “It is certainly a theoretical option to issue a transaction without a rating, but it’s not a practical.”