Discussion point: are ratings agencies right about sovereign ceilings?

Amid all the downgrades to European sovereigns, the ECB recently and pointedly asked all rating agencies (paraphrase) “how can a structured finance bond in Portugal have a debt rating higher than the Portuguese sovereign?” The agencies jumped to the task of creating and publishing their responses.

Moody’s, S&P, and Fitch responded uniformly that the top rating of a securitisation can be as many as six notches higher than the sovereign! These rating agency reports go on for many pages but provide minimal hard insight. One can summarise the lot of them as “sovereign risk is important, we consider it carefully, hence we impose this truly onerous cap of six notches.” What this means is that a securitisation embedded entirely within a country of sovereign rating A- can have a top tranche rated triple-A (without even a clear statement that the sovereign risk requires more credit enhancement). The Moody’s report is best because it discusses most of the important sovereign risks: the obligors of the SPV assets will perform much worse than projected when the sovereign is in default; the financial institutions that act as servicer, collection account holder, and swap counterparty will fail with the sovereign; and enforcement of contracts and property rights may weaken with political turmoil.

But nobody asks obvious questions. If an RMBS bond rating is six notches higher than the sovereign, then the rating agency considers it highly likely when the sovereign defaults that the bond will survive and make all payments with no disruption. What analysis provides this level of certainty? Why is it not far more defensible to say that securitisations strongly embedded within a sovereign will have significant risk of disruption for numerous reasons upon sovereign default? Such reasoning would cap such securitisation ratings at the sovereign level or very near this level.

What do Creditflux readers believe? Is it reasonable to have securitisation ratings well above the sovereign? Should Greek RMBS be investment-grade while the Greek sovereign is single-B?

This article has been submitted by a Creditflux reader as a suggested point for discussion. Mr Wraith describes himself as a wizened rating agency insider traumatised (by) history. Please add your comment below, and send your own suggestions for similar points for discussion to editorial@creditflux.com.