By Kristen Haunss
NEW YORK, Sept 27 (LPC) - US Senator Elizabeth Warren expressed concerns about credit ratings, specifically those for loan securitizations, worried a top US regulator is not doing enough to ensure the independence of the process.
The Democratic presidential hopeful sent a letter Thursday to Securities and Exchange Commission (SEC) Chairman Jay Clayton urging the regulator to take immediate action to study a model that she says unduly incentivizes rating firms to assign better grades.
The issuer-pays model, in which financial institutions pay rating agencies for credit assessments of products they plan to sell, gives firms an incentive to assign better ratings, regardless of risk, so as not to lose business to competitors, Warren wrote.
The US$641bn US Collateralized Loan Obligation market – the largest buyers of leveraged loans, which companies rely on for financing – is a specific concern.
“These securitizations have helped enable increased leveraged loans that are generally poorly underwritten and include few protections for lenders and investors, which creates significant risk to the financial system and the American economy,” Warren wrote, noting that managers of most CLOs are no longer forced to hold retention previously required under the Dodd-Frank Act.
“It is deeply concerning that the SEC has not taken meaningful action to ensure that these securities are accurate and not unduly influenced by conflicts of interest.”
The SEC has missed the opportunity to regulate ratings firms under the authority given by Dodd-Frank, she wrote, years after the credit crisis when ratings were assigned that were said to not accurately reflect risk.
Warren asked Clayton to respond by October 18 to a series of questions including whether the SEC is looking to recommend a business model beyond issuer-pays and what resources does the regulator need to implement the Dodd-Frank reforms for the ratings industry.
Years of low interest rates coupled with growing demand for floating-rate loans saw the US leveraged loan market more than double in size since the credit crisis to top US$1.2trn in assets, allowing companies to borrow increasingly higher levels of debt compared to their earnings while offering fewer lender protections in return.
The boom was buttressed by the US CLO market, which performed well during the crisis, with a record US$128.1bn of the funds arranged in the US in 2018, according to LPC Collateral data. About US$88bn of US CLOs has been raised this year.
Last year Warren expressed similar concerns about “growing risks” in the leveraged lending and CLO markets.
“I am concerned that the large leveraged lending market exhibits many of the characteristics of the pre-2008 subprime mortgage market,” she wrote in a November 14 letter to regulators. “Many of the loans are securitized and sold to investors, spreading the risk of default throughout the system and allowing the loan originators to pass the risk of poor underwriting on to investors.”
She asked Clayton in that letter whether as part of his supervision of Nationally Recognized Statistical Ratings Organizations (NRSROs), he had found any evidence that ratings of loans or CLOs lacked accuracy or were unduly influenced by conflicts of interest.
In a January 31 response, Clayton told Warren that the SEC’s office of credit ratings identified CLO ratings as a specific topic for review. (Reporting by Kristen Haunss. Editing by Michelle Sierra.)