Standard & Poor’s defended its proposed ratings methodology for bond insurers on Wednesday, a day after the plan was harshly criticized.
The rating agency responded to criticism of the plan during a conference call seeking comments on its proposed new criteria, issued Jan. 24, which could lead to investment-grade insurers being downgraded “by one or more rating categories … unless those insurers raise additional capital or reduce risk.”
Dominic Frederico, chief executive of the only active bond insurer, Assured Guaranty Ltd., offered a detailed criticism of the proposal in a Tuesday conference call in which he suggested the rating agency had curiously left reality out of the new credit equations.
Two analysts from Standard & Poor’s responded to some of Frederico’s concerns in the 90-minute conference call Wednesday, during which the name of Assured Guaranty was never mentioned.
The agency said its proposal to exclude unearned premium reserves when performing a leverage test on an insurer’s book was “consistent with” the viewpoints of regulators.
Unearned premiums refer to payments a bond insurer receives up front and recognizes as quarterly income over the life a guaranteed bond.
In its filings to the Securities and Exchange Commission, a bond insurer cannot count unearned premiums as part of its statutory capital, but it may use them to pay expenses and losses.
While excluding those premiums is consistent with a regulatory view, some participants on the call — including Moore Capital’s Larry Vitale — noted that banks are being given up to seven years to respond to new regulations introduced under the Dodd-Frank Act or Basel III, whereas Standard & Poor’s appears to be giving bond insurers only a few months.
“It seems like an awful big change for them to come to compliance with quickly,” Vitale said.
Mark Puccia, managing director at Standard & Poor’s, said a specific timeline for implementing the proposed changes is dependent on feedback received before the March 25 deadline, but added that “multi-year sounds awful long.”
Puccia added that “one year and beyond is something I don’t see happening.”
The details of the proposed leverage test is one of the most contentious proposals recently introduced by Standard & Poor’s, as it would impose limits on how much an insurer could guarantee.
A triple-A rated insurer would have to carry a maximum leverage ratio of 75:1 on its municipal book and 20:1 for structured finance policies.
Frederico on Tuesday applauded the idea of a leverage test but said the proposed version was deficient because it fails to take into account the credit quality or tenor of any bonds in a portfolio. He did not participate in Wednesday’s call.
Puccia conceded that what Frederico said was accurate but noted that Standard & Poor’s does take those factors into account when performing its risk-based capital analysis.
The point of the leverage test, he said, is to impose an independent constraint.
“Regardless of credit quality, we want to simply evaluate the level of exposure a bond insurer has relative to its capital,” Puccia said.
He called the test “deliberately constructed to do something different” and said it could help in detecting systemic risks — one of the failures among rating agencies leading up to the credit crisis.
Frederico’s criticism is that the leverage test can trump the risk-based capital analysis.
For instance, if a hypothetical municipal bond insurer had an implied rating of double-A but its leverage ratio was 110:1, its actual rating would be single-A.
The criteria of the leverage test is specific to bond insurers, but the analysts denied that the industry was being treated any differently than others.
“We are defining AAA as an entity that we would expect to survive a Great Depression-type of macroeconomic scenario,” said Rodney Clark, managing director at Standard & Poor’s. “That’s for all issuers, not just bond insurers.”
Both analysts reiterated that the proposal is open for “serious consideration” until the deadline.
Assured Guaranty is the only active municipal bond insurer after the credit crisis decimated most of its competitors. Its shares climbed for a third day Wednesday, closing at $15.39. The shares were up 8.23% from Friday’s close.
