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Opinion

Rating uncertainties grate on investor nerves

Downgrading tranches and revising criteria will not convince the market that the rating agencies are on top of the sub-prime mortgage crisis.

If the rating agencies are hoping that scrutiny of their role in the position that the US sub-prime mortgage industry finds itself in is abating, they will be sorely disappointed.

The pervading sense that they were caught napping over the stark deterioration in asset quality during 2005 and 2006 is not being helped by their subsequent attempts to assure the market that they are on top of the situation.

On July 12, Standard & Poor’s announced that it had downgraded 612 first-lien RMBS tranches and was revising its sub-prime home equity ratings criteria. Moody’s had itself come out with downgrades to 184 CDO tranches the day before – so the two announcements within 24 hours of each other added to the sense that the sky was falling.

While these downgrades certainly had the effect of adding further disquiet to an already extremely jumpy market, the RMBS tranches affected accounted for far less than 2% of the entire market. But by re-evaluating their criteria for assessing these deals the agencies are calling into question the very foundations on which their models are based. S&P’s revision of its monitoring procedure boils down to sharply increasing severity assumptions – a tacit admission that they got it wrong.

There has been no shortage of commentary in the market agreeing to that proposition, and the offices of Moody’s, S&P and Fitch are ringing to the sound of stable doors being slammed shut after horses have bolted.

Not surprisingly, there is now only one question the market wants answered from the agencies, and it is not on te particulars of how performance has not met their historical assumptions. It is whether there is a realistic prospect of triple-A RMBS tranches getting downgraded.

The downgrade of a triple-A tranche in any securitization is akin to the end of civilization as we know it. It is a mercifully rare event, and a market has to be in spectacularly dire straits for it to happen. But the US sub-prime mortgage market is in dire straits and the market wants to hear from the rating agencies exactly how bad things could get.

In what a recent CreditSights commentary termed a "most extraordinary revelation ", S&P has admitted that it has no specific estimate of how much turmoil the housing market would have to descend into for double-A and triple-A tranches to get hit. It also does not seem to have a clear estimate of the sensitivity of delinquency rates to changes in interest rates.

The problem is that the entire process by which all the agencies monitor these deals and indeed make the decisions upon which downgrades are based now seems to be mired in confusion.

If the rating agencies cannot even give clarity to the market on how bad they think collateral performance is going to get, they cannot hope to give clarity on the likelihood that senior RMBS tranches will get downgraded. In their efforts to calm investor nerves in this most nervous of markets, the rating agencies seem inadvertently to be achieving exactly the opposite.

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