Loan securitizers are bracing for an invasion of backseat drivers. By Wednesday, June 2, issuers and rating agencies must comply with a Securities and Exchange Commission (SEC) rule designed to encourage more unsolicited opinions on ABS. The regulator wants to remove the conflicts of interest in the ratings process that led to inflated ratings in the past and contributed to the financial crisis.

Among the new requirements, when a firm is hired to rate an ABS security, it must notify rivals that did not get the job. The arranger of a security must give all raters — even those it has not tapped — detailed information on the underlying loans, something that previously only the agencies that got the assignment could see. And the agencies will have to rate at least 10% of all deals they inspect, whether or not they are paid to rate them.

Government-sanctioned kibitzing could complicate the gradual recovery in the asset-backed market that began last year.

"Issuers are not really crazy about getting unsolicited ratings that are going to be lower ones than they obtain," said Steve Kudenholdt, partner and co-chair of the capital markets practice at Sonnenschein Nath & Rosenthal.

For one thing, the new requirements may prolong the time it takes to bring deals to market.
"It's definitely going to slow things up," Michael Buttner, Wells Fargo's head of RMBS, said in an interview Friday. "Until you've got all the rules laid out and have worked it through a few times, it's new and it's not going to be as smooth," he said.

Implementation has also been a headache.

"I was on a call about that last night for about an hour and a half, and I was more confused when it ended than when it started," Buttner said at a conference last week sponsored by the Mortgage Bankers Association. "It's all about transparency, which is good. We want transparency," he said. However, "there is still some confusion about how you do that."

Other regulatory changes loom. The SEC and lawmakers have proposed requiring securitizers to retain "skin in the game," or a minimum portion of the credit risk from their offerings. And the SEC has floated rules to create some uniformity around the type of loan information made available to investors.

Collectively, the new regulations will overhaul the way securitizations are done, and that prospect is causing a stir.

"By default, people are reluctant to change, even if it's good," said Sylvia Alayon, senior vice president of national operations at Capital Markets Assessment Corp., a due diligence firm in Fort Lauderdale, Fla. "We're migrating from a business environment or business practice environment where we're used to securitization occurring with just some key data points and that's it, and you move forward. And now the world that we are embarking on is just requiring granular-level loan data."

Under the rule that issuers must comply with by Wednesday, arrangers of a security are to upload loan information that the hired rating agency requests to a secure Web site. There, all nationally recognized statistical rating organizations (NRSROs), as deemed by the SEC, will be able to access that information and weigh in on a deal whether or not the arranger hired them.

Part of the idea is to give smaller agencies more opportunities to become involved in the ratings process. Outside of the "big three" — Moody's Investors Service, Standard & Poor's Corp. and Fitch Ratings — there are a handful of smaller, officially recognized rating agencies like Realpoint and DBRS.

"The purpose was to try to break down the oligopoly and have more competition," Kudenholdt said. "I think it will definitely work in terms of making it possible for ratings agencies that are not hired by the issuer to make an informed rating. It should improve the quality of unsolicited ratings, because actually, ratings agencies doing unsolicited ratings will have access to more information."

The more opinions that are out there, the greater potential for those opinions to differ.
"It should make for some interesting situations, because they may express a different opinion," said Dan Castro, managing director of structured finance analytics and strategy at BTIG, a broker-dealer in New York. "That actually keeps everybody a little more honest."

Buttner said he feared the agencies could offer unsolicited ratings without sufficient explanations. "The 'con' about it is if there isn't clarity about the rationale about why they would differ," he said.
Another question, Buttner said, is how often the unhired raters will weigh in. "If … the ratings agencies don't seize on the opportunity to provide those ratings" regularly, "and just pick and choose and don't do it consistently, then I'm not sure if we get as much value out of that."
The market saw the potential for differing opinions this spring when Redwood Trust broke a two-year impasse in the mortgage bond market and issued a security backed by freshly minted loans without a government guarantee.

Moody's, the only agency hired to rate the deal, gave the senior bonds from the deal the coveted triple-A rating, citing the high credit scores and incomes of the borrowers of the underlying loans. S&P offered up its own opinion on Redwood's deal even though it had not been hired to do so, saying the senior bonds would not have received its highest rating due in part to the number of interest-only loans and the high concentration of loans in a few states. Even deals meeting all of its triple-A standards would have required a stronger credit enhancement, S&P said.

Some experts said the SEC rule may not foster more competition among raters as intended.
"I think it levels the field because those guys have access to it, but the reality is the smaller guys don't have the resources" to offer ratings without compensation, Castro said.

Alayon agreed. "It may be left only to a few players in the marketplace, because they may be the only ones able to do it," she said.

Ultimately, the potential for more varied opinions is going to mean more work for investors.

"The SEC I think is trying to force investors to drop their blind reliance on ratings agencies," said Paul Bossidy, chief executive of Clayton Holdings, a due diligence firm in Shelton, Conn. "As this market comes back, you have to be sophisticated enough to do your own models and come to your own judgments."

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