The asset-backed and commercial mortgage-backed markets may be shaken again by the Fitch/Duff merger.
As the newly minted Fitch rating agency announced a single set of combined ratings for a slew of mortgage-backed and asset-backed deals last week - a long-awaited move that resulted from the recent merger of Fitch IBCA and Duff and Phelps Credit Rating Co. (DCR) - market participants predicted that the as-yet unresolved issue of how regulators will look upon the new ratings will surely rattle the securitization sectors considerably going forward.
Some investors such as mutual funds and pension funds have charters stating a strict need for at least two separate ratings on any particular deal. These buysiders may run into trouble if regulators decide that deals rated only by DCR and Fitch are now considered to have just one rating. Some sources predict these investors will be forced to either dump the securities or mark them down considerably, and then sell them off.
"I wouldn't be surprised if I see some vulture funds forming, pulling out all the investment profiles from these insurance companies and mutual funds, looking to see how much CMBS or ABS they're getting rid of because of this," said one securitization expert. "They might offer them 70 cents on the dollar, or something like that."
"If the National Association of Insurance Commissioners (NAIC) say that Fitch is now one agency, and so it can only be considered one rating, this will impel some firms to divest of singly rated obligations," said Michael Youngblood, managing director of real estate at Banc of America Securities. "Already some paper that was only rated by Fitch and Duff has been trading five basis points wider."
Although there are only a handful of CMBS deals that had only Fitch/Duff ratings, the problem may be more acute for ABS, sources say. Many ABS deals were only rated by Fitch and Duff.
Despite numerous conversations between Fitch and the National Association of Insurance Commissioners (NAIC), the regulatory body of the latter organization has not made an official ruling concerning the ratings issue.
"We have not had a formal request from Fitch in that regard," said Chris Evangel, a member of the securities valuation board at the NAIC in New York. "There is a working group set up, headed by Larry Gorsky, and we've had general conversations with Fitch about the merger, and a general discussion of what the process would be of creating a single set of ratings. But we told them they have to go to our regulators, who make a final decision. We had a meeting with our regulatory body, but there has been no formal request from Fitch at this point.
"When they do make a formal request, we'd be happy to entertain that discussion."
Still, analysts at Fitch report that they've had numerous conversations with the NAIC on the topic, and although there has been no official response, it appears that the regulator is leaning towards looking at the ABS and CMBS deals on a case-by-case basis.
"The NAIC has had no official answer, and they may not have one. Clearly nobody wants investors to be hurt," said Janet Price of Fitch. "We don't think it really affects many bonds. Furthermore, the NAIC is aware that, at the time the deals were rated, there were two opinions on it, and that is the most important thing."
One CMBS expert predicted, however, that the NAIC is going to consider the outstanding bonds as one rating, because the Duff/Fitch teams have already been merged and there is only one credit committee.
"My guess is they're going to sit there and say, This is only one rating,'" the source said. "They're not going to keep them separate. And even if the NAIC says something, somebody may have a contractual obligation to get a second rating.
"They're going to say, Look, I can't sell them but I'm going to put them in a basket to be sold, but I have to mark them down.'"
Since nobody ever contemplated the merger, sources say that it is just not acceptable for some investors to say, "Well, two ratings are best, but one will do also."
"Luckily, some pension funds have are have more savvy accounts and charters and state that at the time of purchase it had to have two ratings," said Michael Hoeh, head portfolio manager at Dreyfus Corp. "That gives managers flexibility to make a rational decision about what to do at that point. However, many portfolio managers are going to have to make adjustments because of this, because there is sometimes strict language in charters about having two ratings."
The matter is even more cloudy for ABS, Hoeh says. "There have been more deals where Fitch and Duff either had a conflict or disagreed in ABS, and it may become a problem for investors that hold that paper. Even the NAIC doesn't have 100% cut and dry mapping for this stuff."
On the upside, CMBS analyst Gail Lee at Credit Suisse First Boston predicts that, at least for CMBS, ratings have been very consistent across the board, and there is a very low chance of differences occurring.
"But going forward, Fitch will have to make some decisions as to which methodologies they're most comfortable with," Lee said.
