1 / 17

The Role of Credit Rating Agencies in the Sub-Prime Crisis

The Role of Credit Rating Agencies in the Sub-Prime Crisis. CRAs – their last call!. Charles Cronin, CFA Head CFA Institute Centre, EMEA. Wien/Vienna 2 nd June 2008. Agenda. Introduction What is Structured Finance? How did it all go wrong Can we blame the CRAs for …? Notching

heather-noble
Download Presentation

The Role of Credit Rating Agencies in the Sub-Prime Crisis

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The Role of Credit Rating Agencies in the Sub-Prime Crisis CRAs – their last call! Charles Cronin, CFA Head CFA Institute Centre, EMEA Wien/Vienna 2nd June 2008

  2. Agenda • Introduction • What is Structured Finance? • How did it all go wrong • Can we blame the CRAs for …? • Notching • The CFA Institute Centre response • The Regulatory response Acknowledgement to Arturo Cifuentes, MD Structured Finance at R.W.Pressprich & Co. New York for some of the slides in this presentation.

  3. What is Structured Finance? Alchemy Genius

  4. What is Structured Finance? The Basic Idea • Senior Bottle • Water 90 l • Poison 0.1 l • = 0.0011 Very Safe • Mezzanine Bottle • Water 6 l • Poison 0.05 l • = 0.008 Drinkerable • Equity Bottle • Water 3 l • Poison 0.85 l • = 0.221 Lethal • Water = 99 l • Poison () = 1l • = 0.01 or 1% 1%  is board line toxic Note – the amount of poison is unchanged only the allocation is different

  5. What is Structured Finance? • Credit Risk - What is it? • It is the Risk of Loss as a Result of a Debtor’s • Inability or Unwillingness to Repay a Debt • • Inability (Cannot): WorldCom • • Unwillingness (Don’t Feel Like It): Argentina

  6. What is Structured Finance? • Ratings and their meanings • S&P - Fitch / Moody’s • AAA / Aaa • AA / Aa • A / A • BBB / Baa • ________________________________________ • BB / Ba • B / B • CCC / Caa • CC / Ca • C / C Investment Grade!? Non-Investment Grade aka “High Yield” or “Junk”

  7. What is Structured Finance? • Issuer-Weighted Default Rates (Year 5) in % [*] • % AAA/Aaa 0.163 AA/Aa 0.718 A/A 1.132 BBB/Baa 3.262 • _________________________________________ • % BB/Ba 9.833 B/B 22.451 CCC/Caa CC/Ca ≈ 40 C/C • Important: ratings measure credit risk • (they do not reflect liquidity, volatility, appreciation potential, etc.; ONLY Credit Risk) • [*] Corporate Default and Recovery Rates, Moody’s Report, February 2007

  8. What is Structured Finance? • Mechanics of a CDO Assets Liabilities AAA/Aaa C = 6% BBB/Baa C = 8% Residual Unrated IRR = 20% Many Assets (rating ≈ B) $100 + Yield ≈ 9% Senior $70 Cash flows (Waterfall) SPV Trust Mezzanine $20 Equity $10

  9. So what went wrong?

  10. So what went wrong?

  11. So what went wrong?

  12. Can we blame the CRAs for …? • Yes and no – Investors need to shoulder much of the blame • Trustees/fiduciaries/managers at fault • Seal of approval • Failures of due diligence • Credit constraint on bond portfolios • Investment managers not incentivised to raise concerns

  13. Can we blame the CRAs for …? • CRAs made some key contributions • The smoking gun – AAA recovery 60¢ on the $1 • Model failure • Default correlations • Failure to disclosure assumptions • An assumption is an opinion • CFAI Code & Standards • Exercise diligence • Act with reasonable basis

  14. Notching • A dark practice? • Unsolicited rating of debt • An anecdote • Sour grapes or sound advice?

  15. CFA Institute Centre response • Capital Markets Policy Council • Change in nomenclature for structured products • Eliminate the use of the term “Investment Grade” • Prohibit “Notching” • Executive level compliance officer at CRAs • Refrain from rating without “robust” analysis • Strong SRO for CRAs • In EMEA responded to CESR & IOSCO consultations

  16. The Regulatory response • CESR – robust and uncompromising • “immediate”, “short term”, “should step in” • International CRA standard setter of all stakeholders • International > European > Regulate • Transparency > model assumptions/which methodology • Human Resources > must be adequate for quality • Monitoring > resourced for timely rating changes • Conflicts of Interest > acceptable interaction w/ Issuers

  17. The Regulatory response • IOSCO? • Awaiting news

More Related