Did The Credit Agencies Just Go Extinct?

Tyler Durden's picture

The recently passed Donk (Dodd-Frank) Finreg abomination, which nobody has yet read is finally starting to disclose some of the interesting side effects of its harried passage. Such as that the rating agencies may have suddenly become extinct. As the WSJ's Anusha Shrivastava discloses: "The nation's three dominant credit-ratings providers have made an urgent new request of their clients: Please don't use our credit ratings." The Moodies of the world suddenly have good reason to not want their name appearing next to those three A letters (at least in Goldman CDO and bankrupt sovereign cases) out there: "The new law will make ratings firms liable for the quality of their
ratings decisions, effective immediately." In other words, "advice by the services will be considered "expert" if used in formal documents filed with the Securities and Exchange Commission. That definition would make them legally liable for their work, meaning that it will be easier to sue an firm if a bond doesn't perform up to the stated rating." And since ratings are officially a part of a vast majority of Reg-S filed documentation, the response by issuers has been a complete standstill in new issuance, especially asset-backed underwriting and non-144A high yield issues, as the raters evaluate how to proceed. Alas, as there is no easy fix, underwriters' counsel and issuers will promptly uncover new loopholes and ways  to issue bonds without the rating agencies' participation. Did Moody's and S&P just become extinct?

More from the WSJ:

Standard & Poor's, Moody's Investors Service and Fitch Ratings are all refusing to allow their ratings to be used in documentation for new bond sales, each said in statements in recent days. Each says it fears being exposed to new legal liability created by the landmark Dodd-Frank financial reform law.

There have been no new asset-backed bonds put on sale this week, in stark contrast to last week, when $3 billion of issues were sold. Market participants say the new law is partly behind the slowdown.

"We are at a standstill right now," said Bingham McCutchen partner Ed Gainor, who specializes in asset-backed securities.

Several companies are shelving their bond offerings "indefinitely," according to Tom Deutsch, executive director of the American Securitization Forum, which represents the market for bonds backed by assets such as auto loans and credit cards. He said he knew of three offerings scheduled for coming weeks that are now on hold.

For those who are still confused as to just how our reptilian legislative system works, here it is. Moody's found out the hard way. Of course, the fact that those short the stock are about to make a killing likely had no bearing in the final outcome of Donk:

The change caught the ratings agencies by surprise. The original Senate
version of the bill didn't include the provision. It was only on June
30, when the Dodd-Frank bill was passed, that the exemption was removed.
The Senate passed the amended version on July 15. The offices of Sen.
Christopher Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.) didn't
immediately respond to a request for comment.

And just like the "scientists" used by BP to validate that the seep caused by the Macondo is not really from the Macondo (until it is proven beyond a reasonable doubt it is from the Macondo, but with sufficient dilution of responsibility that nobody will be impacted), so the rating agencies have been a useful idiot for all the other lazy idiots who refused to do an iota of work an relied on Moodys and S&P. It appears these same dumb money charlatans will once again have to learn what leverage and coverage ratios are.

Ratings providers became a lightning rod for criticism after the financial crisis. Their overly rosy assessments of many bonds, particularly complex securities and bonds backed by subprime mortgages, were blamed for helping fuel the meltdown of the credit markets.

In response, the Dodd-Frank bill revamped how the government treated credit-ratings firms, which receive a special government designation that allows them certain privileges and market access

Once the bill is signed into law, advice by the services will be considered "expert" if used in formal documents filed with the Securities and Exchange Commission. That definition would make them legally liable for their work, meaning that it will be easier to sue an firm if a bond doesn't perform up to the stated rating.

One possible resolution is for the entire underwriting process to go the private route:

One solution to the logjam is for sellers of bonds to offer their deals
privately. That means they would offer ratings that can be used in
private transactions but not in deals registered with the SEC and sold
to the general public. The private market is much smaller and more
expensive than the public one.

Alas, as this will immediately cut off a major portion of the end demand market (the Reg-S, non-144A), the supply-demand equilibrium will likely shift, forcing issuers to offer greater concessions or more generous new issue yields and coupons. And since most companies are beyond stingy when it comes to their balance sheet, this option will likely not be seen as realistic, forcing companies to discover new and improved ways to entirely bypass the MCOs of the world. And that, much more than any latent Wells Notice, will likely be the end of the rating agency paradigm.

h/t Steven