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Attorney General Andrew M. Cuomo today announced that he has reached landmark agreements with the nation’s three principal credit rating agencies that will fundamentally reform the Residential Mortgage-Backed Securities (“RMBS”) market. The agreements with Standard & Poor’s (“S&P”) Moody’s Investors Service, Inc. (“Moody’s”), and Fitch, Inc. (“Fitch”) will dramatically increase the independence of the ratings agencies, ensure that crucial loan data is provided to the agencies before they rate loan pools, and increase transparency in the RMBS market.
Under the agreements with Attorney General Cuomo, the credit rating agencies will fundamentally alter how they are compensated by investment banks for providing ratings on loan pools. In addition, the ratings firms will all now require for the first time that investment banks provide due diligence data on loan pools for review prior to the issuance of ratings. This will ensure that significant data, which was not previously disclosed to the rating agencies, will be received and reviewed by them before any bonds are rated.
“The mortgage crisis currently facing this nation was caused in part by misrepresentations and misunderstanding of the true value of mortgage securities. The tremendous reach of this crisis cannot be understated -- our entire economy continues to feel aftershocks from the collapse of the mortgage industry,” said Attorney General Cuomo. “By increasing the independence of the rating agencies, ensuring they get adequate information to make their ratings, and increasing industry-wide transparency, these reforms will address one of the central causes of that collapse. The reforms agreed to today by S&P, Moody’s, and Fitch should begin to restore investor confidence during what is a very troubling time for the mortgage industry, and I applaud the firms for their cooperation with our investigation.”
Residential Mortgage-Backed Securities are bonds issued by large financial institutions backed by pools of individual home mortgages. An investigation by Attorney General Cuomo found that there were certain structural issues in the RMBS market that needed to be reformed in order to help restore investor confidence. These issues included that credit rating agencies were typically only compensated by investment banks if they were selected by the investment banks to provide an ultimate rating on a loan pool.
The agencies were paid no fees during their initial reviews of the loan pools or during their discussions and negotiations with the investment banks about the structuring of the loan pools. Investment banks were thus able to get free previews of RMBS assessments from multiple credit rating agencies, enabling the investment banks to hire the agency that provided the best rating. In addition, the Attorney General’s investigation found that credit rating agencies were not privy to pertinent due diligence information that investment banks had about the mortgages comprising the loan pools.
The agreements Attorney General Cuomo has reached with S&P, Moody’s, and Fitch will help ensure the independence of the credit rating agencies, require the disclosure of due diligence information to the agencies, and increase transparency throughout the industry. All three rating agencies have agreed to implement the following reforms:
• Fee Reforms. Credit rating agencies are typically compensated only if they are selected to rate an RMBS by an investment bank. Credit rating agencies will now establish a fee-for-service structure, where they will be compensated regardless of whether the investment bank ultimately selects them to rate a RMBS.
• Disclosure Reforms. Credit rating agencies will disclose information about all securitizations submitted for their initial review. This will enable investors to determine whether issuers sought, but subsequently decided not to use, ratings from a credit rating agency.
• Loan Originator Review. Credit rating agencies will establish criteria for reviewing individual mortgage lenders (known as originators), as well as the lender’s origination processes. The credit rating agencies will review and evaluate these loan originators and disclose their originator evaluations on their websites.
• Due Diligence Reforms. Credit rating agencies will develop criteria for the due diligence information that is collected by investment banks on the mortgages comprising an RMBS. The credit rating agencies will receive loan level results of due diligence and review those results prior to issuing ratings. The credit rating agencies will also disclose their due diligence criteria on their websites.
• Credit Agency Independence. Credit rating agencies will perform an annual review of their RMBS businesses to identify practices that could compromise their independent ratings. The credit ratings agencies will remediate any practices that they find could compromise independence.
• Representations and Warranties. Credit rating agencies will require a series of representations and warranties from investment banks and other financially responsible parties about the loans underlying the RMBS.
Deven Sharma, President of Standard & Poor’s, said, “S&P is pleased to work with New York Attorney General Andrew M. Cuomo on these important measures. S&P remains steadfast in our commitment to transparency, openness, and strengthening the governance of the ratings process, and we are pleased these principles lie at the heart of today's agreement.”
Michel Madelain, Chief Operating Officer of Moody’s Investors Service, said, “We are pleased to have reached this agreement with the New York Attorney General and believe these changes are another important step forward in our efforts to improve the independence, transparency and quality of our ratings. Moody’s has been a strong supporter of increased disclosure and stronger due diligence in the U.S. mortgage market, and we are pleased that, with this agreement, these measures will be adopted even more broadly across the industry.”
Stephen Joynt, President and CEO of Fitch Ratings, said, “We believe this agreement contains a number of specific and constructive steps that Fitch and all rating agencies can take to improve the independence and transparency of credit ratings in the mortgage securitization markets. These measures can contribute to restoring investor confidence and stabilizing the mortgage markets.”
The Attorney General’s office has been conducting an investigation into all aspects of the mortgage industry for more than a year, including lenders, securitizers, due diligence providers, and credit rating agencies. On March 3, 2008, Attorney General Cuomo entered into agreements with the Office of Federal Housing Enterprise Oversight and the two largest securitizers of home loans in the United States -- Fannie Mae and Freddie Mac -- requiring them to buy loans from banks that meet new standards designed to ensure independent and reliable appraisals.
The rating agencies investigation was conducted by Assistant Attorneys General Laurence Borten and Daniel Sangeap, under the supervision of Investor Protection Bureau Chief David Markowitz. The Attorney General thanks the United States Securities & Exchange Commission and its staff for its cooperation in this matter.
The Attorney General’s investigation into the mortgage industry, including an investigation into the secondary market, is continuing.
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