Credit Raters Get Slammed Once Again as Too Lenient

The big credit rating agencies came under fire at a Washington hearing Thursday, in what may be a curtain raiser for a new assault on how they do business. All very reminiscent of the flak they got due to the financial crisis a dozen years ago.

Appearing before a panel of the Securities and Exchange Commission (SEC), critics lambasted the agencies—primarily the biggest, Moody’s Investor Service and Standard and Poor’s—for being too lenient on the companies and other debt issuers that they rate.

The raters were guilty of “overvaluation” of many debt issuers in the previous crisis and they still are, said Marc Joffe, senior policy analyst at the Reason Foundation, the libertarian think tank.

The agencies took a public pasting in the wake of the 2008-09 crisis because of their thumbs-up grades for investment vehicles laden with toxic mortgages, which ended up going bust and losing investors a lot.

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As a consequence, regulators and Congress compelled them to make greater disclosure of their methods and also allowed more federally sanctioned competitors. The result, though, is that none of these fledgling rivals has come close to threatening the big two, or their smaller peer, Fitch Ratings.

Now, as a harsh recession (thus far unofficially declared) gathers force, a rash of business failures is expected. Leading up to today’s coronavirus-induced economic downturn, there has been Wall Street grumbling that the agencies allowed too many highly indebted companies to remain in investment grade. Lately, and detractors would say belatedly, several have been downgraded to junk status, with a lot more to come.

Joffe complained that two commercial mortgage-backed securities, which package bonds backed by real estate loans, have been highly rated—and now are shuttered, due to the pandemic lockdown, which makes their futures questionable. One such investment pool is attached to Destiny USA, the mega-mall in Syracuse, New York, and the other to the MGM Grand and Mandalay Bay casinos in Las Vegas. Neither company could be reached for comment.

Joseph Grundfest, a Stanford law professor, told the SEC committee that the “duopoly” of S&P and Moody’s needed better competition. His suggestion: a new agency, sponsored by institutional investors who are the buyers of rated debt. “Otherwise,” he said, “we’re just fiddling around the edges.”

Van Hessen, chief strategist at upstart Kroll Bond Rating Agency, said too many bond buyers depend on the large agencies’ letter ratings (AAA from S&P, for instance, is top of the line), when they should be looking at other factors, such as odds of default. Kroll, which was founded in 2010, touts its own letter grades as giving greater weight to default risk.

Defending S&P, its head of global ratings services said that since the ’08-’09 crisis, the major agency has been subject to much more regulation. “That has been a transformation,” Yann Le Pallec said. S&P was vigilant at preventing conflicts of interest, he added, such as by banning analysts from sales pitches.

“We agree that people shouldn’t just rely on us” when assessing buying bonds, he said.

It’s doubtful that the SEC, under the more lenient rule of Chairman Jay Clayton, is about to start cracking down on the big raters anytime soon. Still, if a rash of failures of well-rated issuers happens, the widespread lambasting of the agencies could well recur.

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Tags: credit rating agencies, downgrades, junk status, Kroll Bond Rating Agency, Moody's, S&P, SEC

The Composition Roofers Local 42 Pension Plan of Cincinnati and the Teamsters IBEW Local Union No. 237 Pension Fund of Niagara Falls, New York, are the 16th and 17th pension funds to receive approval for a reduction in benefits by the Treasury Department under the Multiemployer Pension Reform Act of 2014 (MPRA).

The Cincinnati pension’s reduction plan calls for a flat 45% suspension for all participants, retirees, beneficiaries, and ex-spouses. Participants aged 80 and older will be fully protected, according to law, as would disabled participants, but those aged 75-79 would have reduced benefits.

The voting period for the reduction plan ran from Feb. 19 to March 13 and, of the 462 participants and beneficiaries eligible to vote who received ballots, 168 voted to reject the benefit reduction, while only 51 voted to approve it.

But because 243 did not return a ballot, that means a majority of voters did not vote to reject the benefit reduction, therefore the reduction is permitted to go into effect. The Treasury, in consultation with the Department of Labor (DOL) and the Pension Benefit Guaranty Corporation (PBGC), issued a final authorization to reduce benefits, which was effective April 1.

The plan’s actuary had projected that, without the benefits cuts, the plan would have become insolvent and unable to pay benefits by 2030. However, under the approved reduction plan, the fund is expected to remain solvent indefinitely, according to the actuary.

At the time the fund applied for the reduction, the trustees said they expected the suspension would remain in place permanently.

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The approval for the Teamsters pension, which benefits electrical workers, came on its second application after it withdrew the first one in April 2019. The voting period ran from Feb. 19 to March 13, and, of the 399 eligible participants and beneficiaries who received ballots, 175 voted to approve the benefit reduction, 38 voted to reject it, and 186 did not return a ballot. Because a majority of voters did not vote to reject the plan, the benefit reduction is permitted to go into effect as of July 1.

The IBEW’s benefits reduction plan provides for different treatment for service earned before 2009 than for service earned after 2008. Although the new benefit formula is being applied the same across all participants and beneficiaries, the impact on each individual will vary.

For plan years 1976 through 2008, pension service credits will be limited to a maximum of 1.4 credits in a year. This is the same as the service limit that exists currently for plan years from 2009 and later, therefore all plan years from 1976 on will be treated with the same service limit.

The benefit multiplier for pension service credits earned up through 2008 is limited to $71 from the current benefit level of $85 per pension service credit.

Members who retired or had a break in service that resulted in a benefit multiplier of less than $71 will have their currently applicable multiplier remain in place. And the benefit multiplier for pension service credits earned in 2009 and later will be reduced to $76 from the current benefit level of $80 per service credit.

Participants who retired prior to the effective date of the suspension will have their benefit recalculated using the new service limit and benefit multipliers and using the same early retirement and optional form conversion factors that were applicable at their retirement date.

All other plan provisions, including eligibility and early retirement adjustments, would remain as in effect prior to the suspension of benefits.

The IBEW plan’s actuary had estimated that it would have run out of money to pay benefits by 2028 if the benefits reduction had not been approved.