Credit Rating Agencies’ Cuts on AIG Signal Downgrades Ahead

September 21, 2008

Credit rating agencies, criticized for moving too slowly in cutting ratings on Wall Street firms and the complex instruments they devised, are now accused of acting too quickly.

As the credit crisis enters a new phase, the pendulum has swung too far back, critics argue. The agencies are still missing the mark, only now they are too aggressive, adding to market volatility, or changing their views within days or weeks.

Case in point: AIG.

A week ago, Standard & Poor’s warned that if insurance giant American International Group Inc didn’t demonstrate adequate access to capital in the short term, the rating company could cut its ratings by as much as three notches.

Late Monday, S&P, Moody’s Investors Service and Fitch Rating struck a triple blow to AIG’s investment-grade rating and warned more downgrades could follow.

Hours later, the U.S. government had rescued AIG with an $85 billion loan, and the rating companies scrambled once again to revise their outlooks.

“AIG was a signal they are being more aggressive in today’s environment,” said Joseph Mason, a finance professor at Louisiana State University. “They’ve had their backs against the wall, and they are being forced to cut.”

Credit market turmoil culminated this week in the government loan for AIG, once the world’s largest insurer based on market value; the bankruptcy filing of Lehman Brothers Holdings Inc, spelling the demise of a 158-year-old trading company that was the parent of a major U.S. investment bank, and the hasty sale of Merrill Lynch , the largest U.S. retail brokerage whose advertising symbol is the bull, to Bank of America .

In contrast to the rapid rating downgrades of AIG and structured finance securities linked to troubled mortgages, the rating agencies were criticized early this year for taking too long to cut the ratings of the bond insurers.

Late Thursday, Moody’s said it may downgrade ratings of bond insurers Ambac Assurance Corp and MBIA Insurance Corp , due to increasing losses from subprime mortgage debt.


AIG’s problems come amid widespread destruction of capital on Wall Street that has crippled credit markets. Various estimates say global losses may climb to $1 trillion or more.

AIG insurance contracts on mortgage-linked derivatives, known as Collateralized Debt Obligations, of CDOs, have hit AIG with $18 billion in losses over the past three quarters.

“The rating companies missed the boat on AIG, and now they are playing ‘catch up,”‘ said Edward Grebeck, chief executive officer of Tempus Advisors in Stamford, Connecticut.

Grebeck called AIG “the GE of the industry” and said its rating downgrade may lead to a fresh round of cuts for the sector and related bonds.

“As their ratings go, so goes the industry,” Grebeck said.

A press representative for S&P said ratings represent opinions on the credit profile of a company or outstanding debt, while press officers for Moody’s and Fitch didn’t immediately return calls seeking comment.

“S&P takes rating actions when it feels actions are appropriate to reflect our opinions on creditworthiness,” S&P spokesman Edward Sweeney said.


Rating companies already are signaling that more cuts are coming for corporate bonds and complex debt. AIG’s rating is now four levels away from junk bond status, according to S&P.

Moody’s noted that it is updating its loss projections for subprime residential mortgage-backed securities and even jumbo and prime mortgage-backed securities. On Thursday, S&P cut ratings on various leveraged debt of CDOs.

Those structured finance securities are tied to the U.S. housing market. Massive defaults by U.S. homeowners on their mortgages have resulted in about $810 billion worth of rating cuts for structured finance securities — out of $3.3 trillion of original issuance.

The amount of securities affected by downgrades has almost doubled from six months ago, when the total was about $440 billion, according to S&P.

“AIG is a signal and historic event without precedent,” said John Chambers, managing director and chairman of S&P’s sovereign ratings committee. “This is of greater magnitude” than the U.S. savings and loans crisis, the Nordic banking crisis and the Asian financial crisis, he said.

The decline in issuance of CDOs and the complete reshaping of the financial landscape this week also will likely hit rating companies’ business.

S&P President Deven Sharma told Reuters in June that S&P was looking for growth in emerging markets such as Asia and the Middle East, including Dubai, to close its shortfall from lost business in structured finance.

Moody’s Corp’s Moody’s Investors Service, McGraw-Hill Companies’ Standard & Poor’s and Fimalac’s Fitch Ratings earned huge profits during the U.S. housing boom between 2001 and 2007.

But their stocks plummeted over the past year as U.S. home prices dropped, costing banks and investors billions of dollars in losses.

(Reporting by Walden Siew; Editing by Jan Paschal)

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