In his written statement to the House Financial Services Committee May 20, NCUA Chairman Michael E. Fryzel said the corporate regulations under consideration by the NCUA "will likely prohibit a corporate from relying solely on ratings issued by national rating agencies as a gauge of appropriate credit risk and will, most likely, specify that such ratings may be used only to exclude investments that might otherwise be permissible."
Kevin Brauer, executive vice president at Members United Corporate Federal Credit Union, said he agrees with Fryzel's statement.
"While historically reliable, ratings proved inadequate throughout the current credit crisis, providing a false sense of confidence as ratings volatility and downward migrations have reached historic levels," he said.
In complying with corporate regulations, Members United utilized ratings as a key metric but also reviewed rating agency comments, analysis from other providers like brokers, analysts and industry sources, its own internal modeling, the historical performance of asset types and forward-looking reviews by industry experts.
That being said, Brauer added Members United believes the financial services industry must require significant improvement in the rating agencies' performance. "The rating agencies must maintain their independence and minimize conflicts of interest between rating agencies and issuers," he said.
CNBS President/CEO Brian Hague agreed that national ratings agencies need to eliminate conflicts of interest like issuing ratings to paying customers. However, the methods they used to rate securities were also flawed, he added. "When agencies would stress test bonds, not one ever tested to see what would happen if real estate values declined. They never even modeled a correction to how fast values were rising, which is pretty outrageous to me."
Hague said he's never been a big fan of ratings agencies, recalling a job interview with former U.S. Central Chief Investment Officer Dave Dickens 17 years ago.
"He asked me, 'Can you buy ratings?' meaning would I just rely upon ratings agencies. Just buy AAA paper and feel safe," Hague said. "My answer was no. Even then I didn't believe you could trust ratings agencies to do your due diligence."
Hague admitted that as a provider of credit union investment services, it's self-serving to urge credit unions to outsource qualified investment analysis or hire in-house talent. However, he said plenty of portfolio managers relied on ratings because they didn't entirely understand increasingly complex securitized investments, and they got burned when once-highly rated investments turned to junk.
Hague added he doesn't think ratings agencies will face sweeping reforms.
"They could, but I don't think they would do it themselves nor would the bond issuers force them to," he said. "Neither has any business interest in doing that. I'm not a big fan of legislating everything, but I think a different business model would have to be forced on both ratings agencies and bond issuers."