The country’s credit rating agencies are under the SEC’s microscope


The SEC report, quietly released in January under the vanilla-sounding title “Credit Ratings Bureau Staff Report on Nationally Registered Statistical Rating Organizations,” is provided to Congress annually, as required. the Credit Rating Reform Act 2006. break down the number of key findings, or breaches, from 2016 to 2021 by rating agency size categories – with smaller agencies recording 195 alleged breaches during the period; medium-sized agencies, 145 and large agencies, 147.

“From 2016 to 2021, large NRSROs had an average of 8.2 essential results per review cycle, medium NRSROs had an average of 8.1 essential results per review cycle, and small NRSROs had an average of 8.6 Essential Findings by Review Cycle,” SEC staff note in report. “…large NRSROs report employing 4,691 credit analysts (including supervisors), or about 83.7% of the total number employed by all NRSROs. Small and medium NRSROs, as a whole, employ about 16.3% of all credit analysts employed by NRSROs. »

Large NRSROs, according to the SEC report, are fitch reviews, Moody’s Investor Service and S&P Global Ratings. Medium-sized rating agencies include AM Best Valuation Services, DBRS Inc.. and Kroll bond rating agency (KBRA). Small NRSROs are Egan-Jones Ratings Co.., Mexico HR Assessments and Japan Credit Rating Agency Ltd.

The SEC report also states that the number of core violations in the “2016 review cycle was higher in several areas of review, which was likely related to new and amended rules that went into effect in 2015.”

“Essential findings have generally declined over subsequent review cycles,” the SEC report continues, “indicating greater awareness by NRSROs of applicable laws and their obligations as regulated entities.”

A chart in the report shows that the range of breaches of key findings in 2016 averaged between 14 and 18 across the small, medium and large agency categories. For 2020, the range drops to an average of four to seven violations across all three agency size categories.

For 2021, based on the chart in the report, the average number of critical findings across all three agency categories declined further – averaging two to four breaches across the three agency-sized industries. The greatest improvement over the period was seen in the large agency category sector, which had an average of 18 breaches in 2016. This had declined to an average of around four core breaches in 2020 and two in 2021.

Case examples

The SEC’s report on credit rating agencies details a handful of case examples that better illustrate the nature of the alleged violations of key findings uncovered by SEC examiners – although, again, the examples do not do not include identifying information about specific rating agencies or bond issues. In the case of a large NRSRO, the SEC staff report indicates that the agency did not report an allegation of fraud, for example.

“The NRSRO issued a credit rating on a bond after the bond underwriter disclosed to an NRSRO analyst an allegation of potential fraud regarding the authenticity of a letter of credit on which this credit rating was based. “, says the SEC report. . “Staff also noted that the NRSRO did not remove the credit score for a few months during which the NRSRO became aware of potential fraud.”

In another case involving a mid-sized rating agency, the SEC report noted the following:

“On some occasions, an analyst has participated in a rating committee while holding securities of the rated entity in a managed account. Staff recommended that the NRSRO establish, maintain and enforce reasonably designed written policies and procedures to address and manage conflicts of interest relating to securities held in employees’ managed accounts.

Finally, in another example highlighted in the report involving a small NRSRO, SEC staff found that the rating agency’s conflict of interest policies were lacking.

“The NRSRO policies and procedures did not appear to be reasonably designed…to prevent the occurrence of the prohibited conflict of interest,” the SEC staff report said. “… NRSRO policies and procedures permitted employees to receive gifts of a specified limited amount, but did not limit such gifts to items provided as part of normal business activities, such as meetings.”

Market share

The SEC report also reviews market share information for residential mortgage-backed securities, or MBS. The report defines MBS as “securities secured by US first mortgages on residential properties.” However, it excludes Fannie Mae and Freddie Mac issues as well as “securities secured by non-performing or re-performing mortgages; subprime [or non-prime] mortgages; … real estate loans financing single-family rental businesses [investment properties]; and refinancings of securities previously offered.

This definition means that the MBS transactions analyzed in the SEC report were limited to private label issues secured by prime mortgages, such as high balance mortgages or jumbo loans, for example. In the first six months of 2021, the market share leaders based on the issuance of prime residential MBS, according to the SEC report, were as follows:

  • Fitch, 48 trades in total issuance volume of $21.9 billion, or a market share of 68.1% based on loan pool value.
  • Moody’s, 39 transactions valued at $21.8 billion – 67.9% market share.
  • KBRA, 22 deals valued at $9.1 billion – 28.1% market share.
  • DBRS, seven transactions valued at $3.1 billion — 9.6% market share.
  • S&P, six transactions valued at $2.3 billion — 7.2% market share.

The report also shows that the top residential MBS deals reviewed by the five rating agencies in the first six months of 2021 (a total of 72 deals valued at $32.2 billion) eclipsed the value of rated deals throughout the year. 2020 (80 transactions valued at $30.1 billion). billion). In some cases, however, the SEC report points out, multiple NRSROs may have assessed a particular transaction, representing market share figures greater than 100% on a combined basis as well as any discrepancies between individual agency figures and MBS market totals.

“The highest market shares for the US MBS segment were obtained by two of the large NRSROs [Fitch and Moody’s]“, says the SEC report. “KBRA and DBRS had achieved market shares of over 40% in this segment in 2019 but have since seen their market share decline in 2020 and the first half of 2021.”

Still, KBRA and DBRS, according to the SEC, were quite active in the residential MBS issuance categories not included in the analysis. “For example, DBRS noted 69% of reexecutable mortgage transactions priced in the first half of 2021,” the SEC staff report states.

“Furthermore, DBRS and KBRA were active rating securities backed by subprime [now typically referred to as non-QM] mortgages and risk transfer securities [such as agency credit-risk transfer deals] during the first half of 2021. For subprime mortgage-backed securities, DBRS rated 32% and KBRA rated 28% during the first half of 2021; for risk transfer securities, DBRS rated 50% and KBRA rated 14% in the first half of 2021.”

ESG analysis

Another area of ​​insight in the report relates to ESG-related products and services offered by credit rating agencies and their affiliates. The SEC staff report revealed some areas of concern in this regard.

“Development in the region has grown rapidly and competition has intensified between NRSRO and non-NRSRO suppliers, which has led the [SEC] staff to identify several areas of potential risk to NRSROs,” the SEC report said. “These include the risks that, by incorporating ESG factors into [credit rating agencies] may not adhere to their methodologies or policies and procedures, consistently apply ESG factors, make adequate disclosure regarding the use of applied ESG factors in rating actions, or maintain effective internal controls involving the use in ratings of ESG-related data from affiliated companies or unaffiliated third parties. parties.”

Potential for conflicts of interest also exists, according to the SEC’s analysis, in cases where a credit rating agency “offers ratings and unrated ESG products and services.”

“Standardization has been a challenge, so an issuer may seek to present its own [ESG] program a certain way depending on how they do things,” said Roelof Slump, managing director of US RMBS at Fitch Ratings, in a previous interview focused on the ESG market. “Issuers don’t necessarily all work… to come up with a standard for the entire market.

“…The lack of standardization is something that has been an obstacle, but it is still very early [in the U.S.]. Europe is much more advanced on these issues.

The SEC report notes that KBRA recently released a white paper focused on the ESG market revealing that it “believes that ESG factors that impact credit risk need to be better disclosed….”

The KBRA report itself stated that ESG investing can have lofty goals, such as moving the world towards a low-carbon economy, supporting social inclusion, and reducing inequality.

“However, the current challenges associated with ESG ratings may lead to market distortions and difficulties in distinguishing bad ESG players from good ones,” the KBRA white paper states. “There is no universally accepted standard by which the E, S and G factors are weighted or, in many cases, even measured.

“Given the myriad of risks and challenges, it’s hard to imagine a single ESG score that encapsulates an issuer’s E, S and G profile, because those things mean different things to different people.”


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