After heavy criticism from investors, analysts and bond insurers over Standard & Poor’s new bond insurance rating criteria, the agency is firing back in self-defense. 

S&P — which issued the final criteria at the end of August after sending out a request for comment criteria in January — took heat both from analysts and investors on a conference call in early September and from bond insurer Assured Guaranty’s president and chief executive, Dominic Frederico, last week.

Late last week, S&P issued an additional report looking at the changes made in the final bond insurance criteria in an attempt to clarify confusion.

After being questioned during the conference call on why collateralized-debt obligation criteria was put in the bond insurance rating criteria without notice, Standard & Poor’s wrote that the update was meant to “further enhance the comparability of bond insurer ratings with ratings in other sectors.”

“We did not believe that there was a need to reopen finalized criteria from noninsurance sectors, particularly since the underlying research that created the basis for the relevant criteria has not changed,” the report read.

When speaking to a group of analysts last week at a Keefe, Bruyette & Woods insurance conference, Frederico criticized the agency’s revised leverage test, new capital requirements, and a test applied to an insurer’s exposure to its largest obligors.

Assured’s muni bond insurers, Assured Guaranty Municipal Corp. and Assured Guaranty Corp., both with 'AA'-plus ratings, are the only active monolines in the muni industry.

Frederico criticized S&P leverage test, which he said ignores credit quality and does not include unearned premium reserves as part of the capital base, which is a significant source potentially to pay future losses.

S&P said the leverage test is limited to only 'AAA'-rated insurers because of the possibility of stress associated with either model error or event risk that is not otherwise captured by the AAA stress scenario used in the criteria.

“Higher leverage generally magnifies losses relative to capital, potentially leading to unwarranted multi-category rating downgrades, which we do not generally expect to see at the AAA level based upon our analysis,” a spokesman said, adding that credit stability standards for entities rated lower than AAA allow for greater ratings volatility.

The new rating criteria also reduces the number of municipal issuers to four categories from 16. Frederico complained that now, different types of risk from issuers are put in a single category, such as muni utility districts, general obligation bonds, private higher education, and solid waste.

S&P’s said four categories were not changed from the request for comment criteria, and the four categories enhance the comparability of bond insurer ratings with ratings in other sectors.
A spokesman added that the rating agency received feedback during the 60-day open comment period and gave serious consideration to those comments as criteria was finalized.

“We considered the points raised during the public review and comment period and made certain changes that we deemed appropriate to the finalized criteria,” the spokesman said.

The capital charges were also controversial. S&P said capital charges are the product of frequency of default, and the probability-of-default component in the final criteria uses the same guidelines used to rate corporate collateralized debt obligations.

“We believe these default rates are appropriate given the principle that bonds with the same ratings are generally projected to have a similar probability of default,” a spokesman said.
Frederico and analysts were also quick to criticize the largest-obligors test, which measures a company’s exposure to a single issuer. In the final criteria, the largest obligors test used in the CDO test replaced the original single-risk limit test that was in the “request for comment” criteria.
S&P said the CDO largest-obligors test was used to promote comparability of ratings across sectors. “Losses on a limited number of defaulting credits could be substantially higher than average,” a spokesman said. “We are looking at a worst-case scenario for the largest-obligors test and average outcomes for the capital model testing.”

He added that the single-risk limit test had the potential to disproportionately affect capital assessment, potentially leading to lower capital scores. Under the largest-obligors test, the rating agency said the maximum penalty would be a one-point adjustment to the adjusted capital adequacy score regardless of the number of violations.

“The largest-obligors test modifies the adjusted capital adequacy scores, not the final rating, which other rating factors can mitigate,” the spokesman said. “The single-risk test had no limit to the rating reduction that could occur.”

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