The recent departure of Noel Kirnon, global head of structured finance

at Moody's Investors Service, is the latest in a series of prominent managerial changes at the rating agency. It also serves as another demonstration of the ongoing and all-too-familiar pillage of the structured finance sector.

Rating agencies, whether it is warranted or not, are bearing most of the blame. They have responded to the criticism with a yearlong series of organizational changes and methodology overhauls.

These changes have been imperative in restoring market confidence, industry participants said, but many remain skeptical and believe that a new regime, or additional oversight, does little more than mask the conflict over where the liability lies.

Industry participants have expressed frustration with the rating agencies, which have not directly admitted to any wrongdoing.

While Moody's has not formally tied the departure of Kirnon with a specific trigger event, the announcement coincides with an investigation by law firm Sullivan & Cromwell into its CPDO ratings practices, which showed that internal staff had concealed an error in the model for rating these structures instead of downgrading the securities, for which the ratings were overblown.

President and Chief Operating Officer at Moody's Brian Clarkson announced his departure not long after a Wall Street Journal article in April accused the rating agency of putting competition for new business over quality of ratings. Both Clarkson's and Kirnon's last days are on July 31.

The rating agency declined to comment on layoffs, and Kirnon did not respond to an interview request.

Though the rating agencies have been responsive to regulatory scrutiny, their critics say they are primarily focused on absolving themselves of legal liabilities, that could hinder the resumption of securitization market activity.

On the structuring side, one CDO manager said that the rating agencies have become so scared of making a mistake that every detail must now be deliberated by a committee for several days. "You cannot just get your questions answered directly. If the market weren't so slow, it would be impossible to get anything done," he said.

Part of the problem is that the ratings methodology overhaul has not yet proved effective at bolstering investor confidence given the lack of deal flow, market participants agreed.

This is partially a result of the current pricing dislocation in the market, but also because of rating agency distrust.

"If anybody had any faith in the rating agencies, we would have structured issuance now," said Lou Barnes, a partner at Boulder West, a mortgage banking firm in Colorado. "The market is stark in confidence," he said. "Until someone takes a drink from the watering hole, no one will."

SEC Shines the Spotlight

The latest news on the Securities and Exchange Commission's (SEC) investigation into the rating agencies revealed that these companies were understaffed and that analysts were allegedly overworked and had tweaked ratings criteria to remain competitive. Similarly, the SEC said that the rating agencies made adjustments outside of their models to reduce loss expectations on second liens, without properly disclosing how these decisions were made. The rating agencies were also aware of the growing risk in the CDO market before losses became public, the SEC said.

In response to these allegations, Fitch Ratings said that "the SEC has not informed Fitch of any finding that Fitch acted in a manner inconsistent with Fitch's code of conduct, which is published on the Fitch Web site and modeled on that of International Organization of Securities Commissions (IOSCO)," Managing Director David Weinfurter said. However, the rating agency said that it is currently in the process of updating its policies, procedures and code to make them consistent with the recent amendments to the IOSCO code and the recent SEC proposals.

Mimi Barker, director of communications at S&P, said that "S&P is fully committed to increased openness and transparency, and building on the actions we announced in February, we will continue to take any additional steps needed to improve our processes and ensure they are of the highest quality." Moody's did not return a request for comment by press time.

What Sparked the Fire

Just over a year ago, all three major rating agencies shocked the market when they began downgrading billions in high-grade RMBS securities and CDOs with ABS exposure.

As losses from these downgrades continued to mount, ABS industry participants have pointed the finger all over Wall Street. While investors were scolded for their overuse of ratings as an analytical tool, rating agencies took most of the blame for their opacity and revenue-driven business model.

As a result, rating agency regulation remains a front-burner issue. The industry has been responsive to market complaints by bulking up ratings oversight and risk analysis, with a particular focus on structured finance.

These changes are necessary for market recovery. "In updating their assumptions and criteria, the rating agencies are doing it with a view that the ratings going forward will be stronger," said Douglas Long, executive vice president at Principia Partners.

However, there is still uncertainty in the market over whether these modifications will take hold and if there are going to be more changes than those that have already been made. "What people want out of a rating is stability. There is going to be a period of flux that will only make people more nervous, but it is the reality of the situation and it has to happen to get that confidence back," Long said.

However, conflicts extend far beyond ratings methodology. The SEC addressed this issue in its recent evaluation of the agencies, highlighting their evident conflict of interest when they structured these deals while negotiating new business.

While the agencies have taken steps to combat potential conflicts, given the depressed state of the market the effect is not immediate, and investors are currently requesting very little in the way of rating agency analysis for new deals. "There is less reliance on rating assumptions from investors," the CDO manager said, which also appears to be the primary desire of the SEC and IOSCO.

Without a proven track record, it will take time to regain confidence. "The question is, are the behavioral incentives still there to recreate this problem or have they really solved the fundamental problems with the market and with the structure of the industry?" said Jerome Fons, an independent consultant and former Moody's managing director. He noted that while the rating agencies have improved their models, there is still much uncertainty in the housing market and foreclosures are continuing to rise.

On the other hand, if the market stabilizes, the effect of these agency alterations might not be clear until the market undergoes another down cycle. "You won't really know if they got it right until there is another bursting of a bubble, because a benign economic environment will mask any problems in the underlying model," Fons said.

In response to calls for greater internal scrutiny of rating agency employees and business interaction, there have been a slew of well-received structural changes at the rating agencies, including the addition of newly created positions on the risk-mitigation side.

"It is always good for organizations - especially groups like this that are in some respects viewed as having conflicts of interest and have been through stress - to step back and say: "Do we have the right processes in place? Do we have the right team? The right Chinese walls between groups A and B?" Long said.

In April, Fitch introduced new positions such as chief credit officer in the corporates/financial institutions group and portfolio risk officer for structured finance.

Glenn Costello, managing director and co-head of the rating agency's U.S. RMBS group, assumed the position of portfolio risk officer in the structured finance group earlier this year, reporting to Group Managing Director John Bonfiglio. Managing Director Stuart Jennings, formerly head of Fitch's European RMBS team, became portfolio risk officer for EMEA structured finance, reporting to group managing director Ian Linnell.

In a previous effort to reduce risk arising from conflicts of interest in commercial activities and analytical services, Fitch announced the creation of Fitch Solutions in January 2008, a new division of Fitch Group that would focus specifically on non-ratings content and service businesses, as well as product sales.

S&P also bulked up its risk-mitigation efforts this year after splitting up the position of chief credit and quality officer to enhance ratings oversight. Mark Adelson, previously a principal at Adelson & Jacob Consulting, was hired as chief credit officer, while Neri Bukspan, formerly chief accountant at the rating agency, was placed in the chief quality officer position. Clifford Griep, who was previously in this position, now serves as executive managing director for ratings risk management.

Moody's appointed Jonathan Polansky, group managing director of the rating agency's asset finance group, to the newly created role of structured finance global surveillance coordinator. In his new role, Polansky works closely with the rating agency's surveillance and line of business managers to monitor outstanding Moody's-rated structured transactions.

The rating agency has also added chief credit officer positions in various parts of the company in an effort to strengthen the leadership and oversight in the monitoring process.

These changes have been made in addition to numerous layoffs, which have traditionally been very rare in the ratings industry, which is known for its stable job environment.

"Part of the value proposition for working at a rating agency was that you weren't going to be paid a whole lot, but you wouldn't be worked to death and you had job security," Fons said. "With that out the window, it is going to be difficult for them to attract and retain good people."

But new hires are not on the agenda for rating agencies. Their primary focus right now is to build out compliance and adherence to new ratings policies.

Nonetheless, major hits in the structured finance area have included Jay Eisbruck, a managing director in the asset-backed finance group at Moody's, along with Dan Curry, a managing director in derivatives and managed funds at the rating agency.

In May, S&P let go of senior RMBS ratings professionals including Leslie Albergo, Terry Osterweil, Martin Kennedy and Brian Vonderhorst, as well as managing director Ellen Welsher, who rated esoteric ABS deals.

Fitch Ratings announced the resignation of CDO-group head John Schiavetta earlier this year.

But despite the cynicism among investors about the changes, be it staffing, structure or ratings, there is an implicit value beneath the tarnished image of these agencies that will keep them important. Looking ahead, investors agree that there will be general acceptance of ratings but investors will also increase their scrutiny and ramp up their own internal surveillance of the products they buy.

"Rating agencies fill a very unique and critical role in the market because they provide cross product rating information and information that you can then prove to people outside as well as through your own internal decision-making process," Long said.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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