Wednesday, 28 September 2011

Standard and Poor's, Moody's and Fitch win dismissal of case

Standard and Poor's, Moody's Corp., and Fitch Inc., have won dismissal of a case brought against them in the Ohio courts by five public employee pension funds. The funds claimed that the ratings given to certain mortgage backed securities were faulty and caused them to lose money.

US District Judge James L. Graham, throwing the case out yesterday, agreed with previous case law that the opinions were mere "predictive opinions", and without specific intention to defraud by the ratings agencies, there was no liability. Former Ohio Attorney General Richard Cordray, who filed the suit in 2009, and who has since been replaced by current Ohio Attorney General Mike DeWine, claimed that the ratings assigned to the securities - all AAA or equivalent - were assigned because of payments made by the issuers. Further action by the current Attorney General has been promised.

As stated, the case confirms previous rulings in the US regarding the legal status of ratings, which are considered to be public opinion, protected under the First Amendment to the US Constitution. This was first clarified in 1999 in the Jefferson County case where a suit against Moody's was dismissed. The Jefferson County School District had sued Moody's, claiming that ratings assigned to bonds issued were unfair, causing financial distress to the County. Dismissing the case, the US Court of Appeals of the Tenth Circuit found the statements too vague to be "provably false".

In a similar case in Orange County, also in 1999, a Santa Ana judge also found that without proof of actual malice, Orange County would not be able to succeed in an action against Standard and Poor's. Orange County claimed that ratings ascribed by Standard and Poor's had been too high.

The result? Ratings assigned by CRA's are "public opinions" protected as such under the First Amendment to the Constitution, and therefore without proof of actual malice are not open to legal challenge. For a more detailed overview of the US case law see this post. For the time being, all suits brought against rating agencies have been in the US. It is, however, unlikely that any result in Europe would vary.

Saturday, 24 September 2011

Bank of America - Too Big To Fail No Longer?

Can a bank ever be too big to fail?

After a three month review the rating of long term Bank of America debt has been downgraded a couple of notches from A2 to Baa1. Moody's have cited the reduced chance of a full-scale bailout by the US government should the bank run into difficulties, although the rating agency concedes that should trouble occur, it is still likely that some government help would be likely. According to Moody's, allowing a troubled bank to fail is now more likely than previously because of a realisation that this approach reduces the risk of contamination. Citigroup's long term rating and Wells Fargo's rating have also both been downgraded.

So are taxpayers safe from future bailouts? Are the big banks now no longer "too big to fail"? In its report, accessible here, Moody's states:

"Moody's continues to see the probability of support for highly interconnected, systemically important institutions as very high, although that probability is lower than it was during the financial crisis. During the crisis, the risk of contagion to the US and global financial system from a major bank failure was viewed as too great to allow such a failure to occur -- a view borne out in the aftermath of the Lehman failure. This led the government to extend an unusual level of support to weakened financial institutions and Moody's to incorporate the expectations of such support in its ratings. Now, having moved beyond the depths of the crisis, Moody's believes there is an increased possibility that the government might allow a large financial institution to fail, taking the view that contagion could be limited."

So Moody's believes that the worst of the financial crisis is over and that we are emerging into the sunny uplands of recovery? Maybe not, however there seems to have been a shift in perception that contagion can now be stopped not by bailing out huge financial institutions, but by letting them fail. There are obviously political implications in protecting the taxpayer from more massive bills (more on this later), however provisions in the Dodd-Frank Act that work to reduce interconnectedness among financial institutions can also explain this. Under rules recently finanalized by the Federal Deposit Insurance Corporation (FDIC), the orderly liquidation authority set out in Dodd-Frank sets out a clear intent to impose future losses on bond holders in the event that a systemically important bank - such as the Bank of America - was nearing failure.

However, as yet the parts of Dodd-Frank that would serve to reduce interconnectedness among financial institutions, such as resolution plans or changes to over-the-counter derivatives markets, are still pending. It would therefore be extremely difficult for an orderly liquidation of an institution the size of Bank of America to occur at the present time, and consequently Moody's believes that for this reason, should disaster strike, the government would still be compelled to provide some financial support. Reliance on the ordinary liquidation authority to resolve a systemically important bank would prove too disruptive to the marketplace and wider economy, leading to a situation almost as undesirable as those Dodd-Frank was designed to avoid.

Bank of America, according to Moody's is still exposed to "potentially significant" levels of risk related to both residential mortgages and home equity loans that are still languishing on its balance sheet. Moreover, while Bank of America has taken steps to improve its capital and liquidity positions, and while Moody's believes that it has an ample buffer to absorb any losses that might occur as a result of bad debts, a deterioration in the economic environment or adverse legal rulings on claims against it might serve to tip the balance against the bank's long term financial stability. Of course, these latter are not within the direct control of management of the Bank, meaning that short of further increasing their "modest" capital and liquidity, there is little more the Bank can do except weather the storm out. Of course, following a downgrade of long term debt by the CRA, this one option available to the Bank of America is now just that little bit harder.

So can a bank ever be too big to fail? The obvious answer has to be yes, however the political climate in which a financial crisis materializes should not be underestimated. Is Moody's taking into account the rise of the Tea Party movement in the US? Considering Obama's difficulties in raising the debt ceiling, and the way in which a left-leaning congress balked at previous bailouts, the increasingly vocal right wing in American politics is likely to signal the end for taxpayer support of financial institutions.

Tuesday, 20 September 2011

Moody's praise Italian Austerity Budget for Securitizations

As stated in the previous post, the recent downgrade of Italian sovereign debt by Standard and Poor's has prompted a few raised eyebrows at Moodys' unchanged rating of the debt. Moody's weekly report available here praised the Italian austerity measures as "surprisingly positive for term securitizations". The measures abolish the 20% surcharge on the cumulative amount of interest that has accrued on bonds that amortise in their first 18 months. The measure is credit positive for securitization because they no longer will bear negative carry. Negative carry results from lower interest earned on retained principal than interest paid on notes, according to David Bergman, analyst at Moody's. By removing the surcharge, there is no longer a need for a lock-up period, thereby saving negative carry costs.

By contrast, the consensus at Moody's appears to be that the other austerity measures expand on earlier measures but will have little effect. The latest round of measures aim to eliminate government deficit by 2013 as opposed to the earlier 2014. The measures contain the usual you'd expect to find in deficit reduction plans - increased taxation and reduced spending, and again, as in Greece and much of the rest of the Eurozone, a crackdown on tax evasion forms a significant element of the anticipated increase in tax revenue. A further one point increase in VAT to 21% will come into effect on 17th September, and an extra levy on those earning over €300,000 is also being introduced.

More here when Moody's reappraises Italian debt this week.

The austerity measures are included in law decree 138/2011, which in Italy is popularly called “Manovra Bis”.

S&P Downgrade Italian debt

Standard and Poor's yesterday downgraded Italian sovereign debt to A with a negative outlook. This means that further downgrades are still possible. This means that Italy's Standard and Poor's rating is now 3 notches below that assigned by Moody's, which announced last week its intention to review the Italian measures brought in to deal with the debt problems.

As is usual with these things, the base rate of borrowing rose, leaving yields on 10 year Italian bonds at 5.80% this morning, the highest since the European Central Bank started buying Italian and Spanish bonds in August, according to the FT. By contrast, 10 year German Bund yields this morning were at a low of 1.75%.

Standard and Poor's cited Italy’s “weakening economic growth prospects” and the difficulty of the “fragile governing coalition” being able to “respond decisively” to the crisis, however Berlusconi responded by calling the downgrade political. The Italian government passed an an austerity package just six days ago, however Standard and Poor's has clearly not been much reassured. It would appear that concerns surrounding Italy's ability to deal with the debt crisis are as much about political capability than fiscal stringency.

The Eurozone may be preoccupied with an imminent Greek default, and while this would be tricky and painful, Greece's economy could - just about - be propped up by the rest of the Eurozone, should it choose to do so. However the larger Italian economy is not in this position, and as such any prospect of Italian default should signal something akin to a "save yourselves" policy turnaround. And then there's Spain...

The European institutions have, predictably, reacted angrily to the news, and have threatened a third round of regulation of CRAs, setting up a wholly independent European rating agency. Commentators have largely been skeptical about this threat, but more here if and when the plan is taken forward.

Wednesday, 14 September 2011

The American Downgrade

This is an interesting post on modeled behaviour and the eponymous downgrade:

Downgrade of French Banks

Moody’s has downgraded by one notch top French banks Societe Generale and Credit Agricole while leaving BNP Paribas on negative watch. The agency said that during the review, Moody's concerns about the structural challenges to banks' funding and liquidity profiles increased, in light of worsening of refinancing conditions. Moody's cut SocGen's debt and deposit ratings by one notch to Aa3 from Aa2. The outlook on the long-term debt ratings was negative. For Credit Agricole, Moody's downgraded its BFSR by one notch to C from C+, and cut its long-term debt and deposit ratings by one notch to Aa2 from Aa1.
Credit Agricole and Societe Generale have seen their share prices fall 60% and 65% respectively since February, while BNP has fallen 53% over the same period.
Analysts have welcomed this move as the Moody's rating was slightly elevated compared to other agencies.