S&P, Moody's Must Be Clearer on Asset-Backed Ratings, BIS Says

By John Glover

July 4 (Bloomberg) -- Moody's Investors Service and Standard & Poor's must be clearer and more detailed in their ratings of asset-backed securities and the risks of underlying collateral, the Bank for International Settlements said today.

The firms need to make rating documentation more accessible for investors and be more transparent about how they assess bonds that package mortgages and other debt, according to a report from the Committee on the Global Financial System, which meets under the auspices of the BIS in Basel, Switzerland.

Moody's, S&P and Fitch Ratings underestimated the severity of the worst U.S. housing slump since the Great Depression, the BIS report said. The failure of some bonds linked to U.S. subprime mortgages triggered $403 billion of bank writedowns and losses worldwide, contributing to the credit crunch.

Ratings companies ``should enhance the information underlying'' their grading of asset-backed securities, the BIS committee said in the report. ``Better information on the key risk factors'' of the ratings is needed, and the companies ``should take system-wide risk into account.''

Ratings companies are under pressure from governments and regulators to improve practices which may have contributed to the lending squeeze and economic slowdown.

The limited historical information used in ratings firms' models made the losses worse and the companies also miscalculated the risk of mortgage sellers relaxing their underwriting standards at around the same time, according to the BIS report.

`Taken Advantage'

``Some weakly capitalized originators may have taken advantage of transparent rating agency criteria, enabling borrowers to misrepresent occupancy, income, downpayment source and/or property appraisals,'' the BIS said.

The BIS report is part of an attempt by governments and regulators to give greater scrutiny to the role and practices of credit-rating companies in securitizations.

European Union finance ministers will back a call for stricter oversight, requiring ratings companies to register with authorities, in a draft statement approved for a meeting next week and obtained by Bloomberg News. The U.S. Securities and Exchange Commission requires ratings companies to register and is attempting to abandon a requirement that money-market funds buy short-term debt carrying a high grade from at least two ratings firms.

Investors ``felt that the use of ratings in regulatory frameworks had underpinned revenues and warranted further review,'' the BIS said.

The Committee on the Global Financial System is chaired by Donald Kohn, vice chairman of the Federal Reserve. The BIS was formed in 1930 and acts as a central bank for the world's monetary authorities.

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net