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23 May 2014

Reuters: Rating agencies stand by sovereign caps

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CRAs sought to shield their ABS rating logic from criticism that their link to sovereign rankings is hampering the resurgence of the sector and neglecting market performance.

"We believe our current rating methodologies are justified, and we don't think that they are significantly constraining securitization issuance prospects", S&P said. The agency highlighted other factors that limit ABS markets, such as the broader economic and credit downturn and the regulatory risks that lie ahead.

Members of the European Central Bank have repeatedly pointed to the reliance of ABS ratings on sovereign ratings as a hurdle on the road to redemption of the ABS market.

And further criticism could follow the joint statement issued in April by the Bank of England and the ECB in which they said that "the reliance on ratings by credit rating agencies may lead to unwarranted pro-cyclicality effects". They said at the time that a more substantive paper would be issued in May, and they called for regulatory relief on securitisation. Regulators should "be careful in attributing to the credit rating agencies" the role of drivers of investor behaviour, said Gordon Kerr, head of European structured finance research at DBRS. He argued that "it is rather the nature of capital markets to be procylical" and to react to macro risks.

DBRS is the only agency that doesn't apply a hard sovereign rating cap, believing "each transaction should be looked at in its own merit", Kerr said. The other three agencies said the cap was justified by the severity of risk that ABS would face in case of country defaults and other major macro country events. "We believe it is impossible to completely de-link structured finance ratings from the creditworthiness of the relevant sovereign", Fitch said in a report last month, confirming caps of ABS ratings to a maximum of six notches above the sovereign local currency issuer default rating.

And this view is shared by other raters. "Apart from credit enhancement, portfolio diversification" and other ABS back-ups, "you can't possibly immunize structured finance if the sovereign is under stress", said Neal Shah, managing director of structured finance at Moody's. The cap applied on ABS ratings varies between countries, and is determined by macro factors, counterparty and operational risk analysis in addition to the sovereign ceiling. According to the Moody's model, Irish, Spanish and Portuguese ABS are capped at four notches above the respective sovereign ratings - which means at Aa3, A1 and Baa1 respectively.

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© Reuters

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