AAA to CCC and Other Rating Agency Horror Stories

Yves Smith at Naked Capitalism submits:

The news from rating agency land goes from bad to worse.

This Bloomberg article does much to explain why investors are avoiding subprime like the plague. AAA paper revealed to be CCC. Repeated incidents of financial institutions saying they have no/little subprime exposure, then shortly thereafter fessing up that they have a lot. And rating agencies, like the emperor who has suddenly realized he is naked, trying to disguise the fact that the data underlying their models isn't germane.

While it was only $254 million of face value of CDO paper that was downgraded from AAA to CCC, that sort of revison is unprecedented. It's worse than turning gold to lead, it's closer to revealing that gold is actually nuclear waste. And the fact that it happened to several collateralized debt obligations suggests that other AAA rated tranches are similarly close to worthless.

From Bloomberg:

Last week, Standard & Poor's butchered the ratings on $3.2 billion of debt from structured investment vehicles spawned by Solent Capital Partners LLP in London and Avendis Group in Geneva. About $254 million was slashed from the top AAA grade to CCC+ and CCC -- slides of 16 and 17 levels, triggered by their investments in mortgage-backed bonds.

Think about that for a second. You left the office Tuesday owning a AAA rated security. By the time you got back to your desk on Wednesday morning, it was eight steps below investment grade in a category S&P defines as ``currently vulnerable to nonpayment.'' Try explaining that to your pension-fund trustees....

DBS Group Holdings Ltd., Singapore's biggest bank, said on Aug. 7 it had S$1.4 billion ($921 million) at stake in collateralized-debt obligations. This week, it boosted that total to S$2.4 billion. It seems the bank had overlooked its commitment to a unit called Red Orchid Secured Assets....

A rare moment of comedy arises from what Moody's Investors Service had to say about the oversight. ``I don't think DBS will be the only one who has missed something the first time,'' said Deborah Schuler, a senior Moody's analyst in Singapore....

Moody's recently added some new phrases to its lexicon of code words. When the rating company refers to ``updating its methodology'' or ``refining its risk assessments,'' what it really means is that its historical models say absolutely nothing about how the future might turn out.

Last week, for example, Moody's summarized ``the most recent refinements'' to how it treats bonds backed by so-called Alternative-A mortgages. ``In aggregate, the change in our loss estimates is projected to range from an increase of approximately 10 percent for strong Alt-A pools to an increase of more than 100 percent for weak Alt-A pools,'' Moody's said.

So a mortgage-backed security with a rating based on, say, a 1.5 percent loss rate might now suffer 3 percent losses in its collateral, Moody's said. How's that for missing something the first time?