Cuomo, Rating Agencies Announce Agreement on RMBS; Will Rate Lenders

New York Attorney General Andrew Cuomo confirmed Thursday morning that his office had entered into an agreement with key rating agencies that will see Fitch Ratings, Moody’s Investors Service and Standard & Poor’s Ratings Services make some big changes to the process of rating residential mortgage-backed securities. News of the deal was leaked to the media on Wednesday. Under the agreements, the credit rating agencies will fundamentally alter how they are compensated by investment banks for providing ratings on loan pools. In addition, the ratings firms will all now require that investment banks provide due diligence data on loan pools for review prior to the issuance of ratings–something that wasn’t required in the past, and that rating agencies had said hampered their ability to correctly rate new issuances. “The mortgage crisis currently facing this nation was caused in part by misrepresentations and misunderstanding of the true value of mortgage securities,” said Cuomo. “By increasing the independence of the rating agencies, ensuring they get adequate information to make their ratings, and increasing industry-wide transparency, these reforms will address one of the central causes of that collapse.” As expected, as part of the agreemnt, the New York AG’s office said it had terminated its inquiry major credit rating agencies, which began in August 2007. Investor anger, new standards for originators While Cuomo painted the agreement as a step forward for the industry at a press conference Thursday morning, investors that spoke with HW earlier on Wednesday were incensed at the deal. “[The rating agencies] commit highway robbery, and get off scot-free because they’re going to name the make and model of the car they drove to do it?” said one MBS investor, who asked that his name not be used. “Unbelievable.” While not confirmed by Cuomo’s office, it’s believed by sources close to the negotiations that all three agencies will also assist the state AG in an ongoing investigation into the practices of investment banks responsible for issuing mortgage-backed and related securities. Among the changes put into place, the rating agencies will establish a fee-for-service structure, where they will be compensated regardless of whether the investment bank ultimately selects them to rate a RMBS. In the past, agencies were only paid if an issuer selected them to rate a deal. Perhaps more importantly, the agreements stipulate that the agencies develop criteria for and begin rating originators responsible for providing the collateral that forms the core of any RMBS securitization. Ratings of individual mortgage lenders, as well as lenders’ origination processes, will feed into the overall ratings process for any new deal; currently, only mortgage servicers have been rated on a third-party basis as relevant to deal performance. Also being put into place are stringent due diligence requirements prior to issuance — using criteria they will define, rating agencies will receive loan level results of due diligence and review those results prior to issuing ratings. All are big changes for an industry that has been placed under fire from investors, the media, and legislators as partly fueling the mortgage credit mess — but investors that spoke with HW had mixed reactions to the news. “We need this sort of reform, yes,” said one fund manager, who asked not to be named. “But to allow the Moody’s of the world to increase their revenue base, dictate the future terms of engagement, while getting a hall pass for prior misconduct, it just doesn’t pass the smell test.” A potential larger question remains yet unanswered as well: how will the agreed-upon changes be received by the Securities and Exchange Commission? SEC chairman Christopher Cox has said the regulator will roll out a new set of standards for the ratings process on June 11, and it’s unclear if or how the agreement announced today will play into any new regulation put in place by the SEC. Calls to Cox’s office for comment were not returned by the time this story was published.

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