A panel at ASF 2011, which is being held in Orlando this week, discussed the implications of the legislative mandate under 939A of the Dodd-Frank Act to reduce reliance on credit ratings. Panelists also explored potential alternatives to credit ratings.

This section requires the Office of the Comptroller of the Currency (OCC) and other federal banking agencies to remove references to credit ratings on a security or money market instrument and replace them with substitute standards of creditworthiness.

Reginald Imamura, executive vice president at PNC, said that the American Securitization Forum has been working with the agencies to ensure that whatever alternative creditworthiness standards that are developed promote understanding by banking firms of the risks in their securitization exposures and that these policies focus on actual asset performance, among other things.

“What we can’t say is use credit ratings as a backstop,” said Mark Ginsberg, a risk expert at the OCC. Ginsberg said that regulators are looking at the possibility of using the internal assessment approach. However, these criteria can be applied differently depending on the securitization exposure, and the use of these might not have sufficient supervision.  There is concern also that this would put smaller banks at a disadvantage versus their more sophisticated counterparts.

Debbie Toennies, a managing director at JPMorgan Securities, said that institutions modeling their exposures need a way to ensure for accuracy. She suggested exploring the use of National Association of Insurance Commissioners ‘(NAIC)  approach.

The NAIC hired PIMCO in 2009 to develop modeling techniques to get a better idea about the risk associated with RMBS for life company capital adequacy purposes. And in 2010 it hired BlackRock to develop such modeling techniques for CMBS securities as well.

Gagan Singh, chief investment officer at PNC Bank, said that the problem with using credit ratings is that there is a fundamental misalignment between stressing losses on ABS and the rating, which is based on the probability of default. “You could have very levered securities but have a low probability of default,” he said. He believes that modeling capital standards, whether using the external or internal-based approach, should be aligned to expected losses on the securities.

“We welcome the move away from ratings,” said Singh, adding that investors have used these standards as crutches.

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