An eye toward transparency, accountability
Weekly market view from NewOakby Ron D’Vari, CEO, & James Frischling, President
NewOak is an independent financial services advisory firm built for today’s global markets. Led by a team of experienced market and legal practitioners, NewOak provides a broad range of services across multiple asset classes, complex securities and structured products for banks, insurers, asset managers, law firms and regulators, including financial advisory and dispute resolution, valuation, credit and compliance, risk management, stress testing, model validation and financial technology solutions. We have analyzed or advised on more than $4.5 trillion in assets to date.
Last week the Securities and Exchange Commission (SEC) adopted the final requirements for nationally recognized statistical rating organizations (NRSROs) to strengthen the overall quality of the credit ratings process and provide a more methodical transparency with a much higher degree of accountability. There has been a great deal of discussions on deficiencies of various proposed models such as: 1) NRSRO assignment system for ratings, 2) the issuer-paid model, and 3) non-solicited NRSRO review process.
In 2011 and 2012, the SEC proposed a number of rules concerning the rating agencies. However, many of the proposed rules had not yet been finalized until last week due to SEC’s focus on other aspects of the Dodd-Frank Act. In November of 2013, in relation to requirements governing Federal Home Loan Banks, Federal Housing Finance Agency (FHFA) adopted specific rules that scrubbed certain sections that referenced credit ratings and substituted them with more explicit internal analytical standards and criteria for assessing credit quality.
Some of the key areas expressly addressed in the final rules are:
- (i) the credit ratings assignment system for asset-backed securities (ABS)
- (ii) effectiveness of the SEC’s system to encourage unsolicited ratings of ABS
- (iii) a workable alternative to the issuer-paid model for credit ratings
The final rules implement the requirements of Section 932, including (i) reports of internal controls over the ratings process, (ii) the transparency of ratings process and performance, (iii) steps to be followed when adopting or revising ratings methodologies, (iv) training, experience and competence standards and a testing program for ratings analysts, (v) disclosure of requisite qualitative and quantitative information about the credit rating, and (vi) disclosure of certifications from providers of 3rd-party ABS collateral due diligence.
While compliance with the new rules look daunting, they provide the only path to ultimately regaining investors’ confidence in ratings and securitization. We expect the SEC and other regulators will continue examining the practicality and effectiveness of the new requirements and adjust them over time based on how the rules perform in the field and the associated costs.
City of Detroit and Municipal Finance on Trial
The future of Detroit goes on trial this week when a bankruptcy judge is asked to approve a plan that will set the stage for the city to exit bankruptcy. However, in deciding the fate of Detroit, which marks the nation’s largest ever municipal bankruptcy, the judge will also be setting a precedent on municipal bankruptcy and will be signaling things to come in “muni-land”.
The outcome of the bankruptcy trial will determine the fate of the city and its less than 700,000 residents. However, also at trial will be the powers and limits of municipal bankruptcy. With so many other cities struggling to meet their obligations, the outcome will be watched closely as it may provide a roadmap for how other, albeit smaller, municipalities work through their own potential Chapter 9 process.
There are many moving parts and specifics to Detroit, but it’s safe to say that financial creditors believe they are being treated unfairly in the
Detroit proceedings when compared to other creditors, such as retirees. A number of capital market debts may be repudiated entirely while municipal retirees are being protected. Then there’s the issue of whether selling off valuable assets to pay creditors should be off limits when the assets represent the city’s substantial art collection.
An outcome that is deemed to be too onerous on the financial creditors may provide a roadmap for other municipalities to follow to reduce their debts and emerge from bankruptcy, but it could also result in raising of the cost of borrowing.
The monoline insurers, which will need to payout on the financial obligation shortfalls, are most at risk and so are the parties that are most vocal about the proceedings. If the outcome goes against the financial creditors, expect the cost of insurance to increase and the reliance by municipal bond buyers on insurance to decrease as a result.