Another Blow to Rating Agency Credibility

Yves Smith of Naked Capitalism submits:

A Bloomberg story today tells us that CreditSights found that AAA ratings for a new type of credit derivative may be as likely to default as junk.

In a report titled "Distressed CPDOs: We're Doomed!", CreditSights raised doubts about the ratings of constant proportion debt obligations, which use credit default swaps as a means to bet on the likelihood of default of a basket of investment grade companies. As Bloomberg reported,

``If you assume defaults and downgrades come in bunches rather than being evenly spaced out, CPDOs' default rates are more what you would expect for low junk ratings than for triple- A,'' David Watts, a CreditSights analyst in London, said in a telephone interview yesterday.

In slowdowns, corporate downgrades do become more common. This is a pretty basic analytical issue for Moody's and Standard & Poors to have missed. However, the market appears to have been skeptical even before the CreditSights report was issued:

The CPDO model is being challenged as worsening perceptions of credit quality reduce the value of the credit-default swap contracts included in the securities. Those CPDOs that provided insurance on the 125 companies in the CDX index in March for a premium of 36.75 basis points, or $36,750 for every $10 million of debt, will have to pay nearer 70 basis points to end the contract when the index rolls on Sept. 20, based on current prices....

Prices of CPDOs dropped to as little as 70 percent of face value last month.

The (relatively) good news for rating agencies is that the amount of CPDOs outstanding is small. Bloomberg estimates the market as being in excess of $4 billion. But with rating agency credibility in tatters, more evidence of their shortcomings is the last thing they need.

Add Your Comment

Report Abuse

Archive

Categories

Links