Sunday, May 18, 2008

The Bank of England: Victim of "Rating Shopping"?

(FT Alphaville) Along, perhaps, with bankers’ bonuses, trader’s serotonin levels, and a gross consumer proclivity for debt, “ratings shopping” ranks as a familiar trope of the credit crunch.

Ratings shopping is the process by which a bank - or any issuer - chooses for the assessment of its debt issue, the rating agency which it understands will give it the “best” ratings, based on extant methodologies. Behind the simple dynamic is what the rating agencies elliptically refer to as an “iterative process”: whereby bank goes to agency and says, ‘we want triple-A. How can we structure this deal to get it?’ Agency, of course, bends backwards to let it happen.

The process, on the bankers’ side, was motivated by the opportunity to craft poor quality mortgage debt, with high risk weightings into high-quality triple-A and glean all the benefits from it. Lots of investors were happy to buy that triple-A.

The Bank of England, of course, has just identified itself as one such “investor”. And as the FT on Friday reports, the bank’s special liquidity scheme is now looking likely to have £90bn in tenders for swaps from the off - nearly double the £50bn first mooted when the scheme was announced a month ago.

The collateral naturally has to be triple-A. Triple-A, afterall, is riskless - or at least, near riskless - stuff.

Such a reliance on a rating, though, is just what the FSA condemned as a major factor in the current crisis. Is the BoE being tricked by triple-A?

Mortgage lenders like HBOS and Alliance & Leicester have been busy securitising - respectively structuring £9bn and a £10bn securitisations specifically for use in the SLS. As FT Alphaville reported, at the time, the HBOS transaction had clearly been finessed quite heavily to scoop the triple-A:

Firstly, HBOS has written a call option into all of the new issues, which implies, even with a maturity in 2042, this is only being seen as short term transaction. Secondly, the notes are backed by a “substantial substitution structure” according to a Halifax spokesperson, which presumably was a key enhancement making the triple-A achievable.

The ECB, at least, is worried (from the FT):

the European Central Bank on Thursday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” that the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for Treasuries at the ECB.

No comments: