Journalism in the Public Interest

What Investment Bankers Say About Rating Agencies Behind Their Backs

Credit-rating agencies are supposed to make independent judgments about the risks of a deal. But in their pitches for state business in tobacco bonds, bankers bragged they could manipulate the raters to get favorable treatment for their transactions.

Bankers Brought Rating Agencies ‘To Their Knees’ On Tobacco Bonds

Wall Street pressed S&P, Moody’s and Fitch to assign more favorable credit ratings to their deals and bragged that the raters complied. Now many of the bonds are headed for default.
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The bonds in question were backed by payments from a massive 1998 government settlement with Big Tobacco over health care costs related to smoking. As ProPublica has reported, the securities have turned out to be riskier than advertised, spurring losses for investors and fiscal headaches for state and local governments.

Below are excerpts of statements by Wall Street bankers from some of the 140 documents ProPublica obtained through public records requests. The documents typically were sent to the states by banks competing to underwrite the bond issues.

When asked by ProPublica about the documents, raters S&P, Moody’s and Fitch didn’t address specific deals but said they don’t adjust their criteria despite what bankers claim. The banks declined comment; one bank, UBS, pointed out that it is no longer involved in the business, which it left in 2008 amid a broader retreat from municipal bond underwriting.

The Deal: $518 million Washington State Tobacco Settlement Bonds

“Goldman Sachs also has an enormous head start with the rating agencies … Moody’s and S&P have both agreed with our analyses that CPI and short-term rates are very correlated, thus providing a very desirable matched liability characteristics to the state … ”

Goldman Sachs, 2002

The Deal: $2.3 billion New York State Tobacco Settlement Bonds

“… UBS PaineWebber spent an intensive 10 days redefining the statistical ranges employed in Moody’s tobacco stress tests. Both Fitch and S&P also undertook a new look at their rating criteria and at the end of the day, both Moody’s and S&P made beneficial adjustments to their rating criteria.”

UBS, 2002

The Deal: $3.1 billion California “Golden State” Tobacco Settlement Bonds

“… Our discussions with the rating agencies had the direct impact of enhancing net proceeds for the desired rating category."

Merrill Lynch, 2005

The Deal: $832 million Iowa Tobacco Settlement Bonds

“Bear Stearns is actively involved in discussions with Moody’s regarding favorable changes to their rating criteria. As a result of proactive dialogue initiated by Bear Stearns … Moody’s consumption starting point and consumption decline cases have been favorably negotiated"

Bear Stearns, 2005

“We have educated the rating agencies on new developments and aggressively negotiated ratings and stress requirements to maximize upfront proceeds for our clients. In fact, we negotiated new stress tests with Moody’s Investors Service earlier this year that we believe will be directly favorable to the Authority, and we have incorporated these assumptions into our numerical analysis.”

Citigroup, 2005

The Deal: $491 million Michigan Tobacco Settlement Bonds

“Other firms were quick to leverage our analysis as Fitch was dropped from both the Iowa and Sacramento County tobacco securitizations. Fitch reached out to UBS for input so that they would fall in line with the other ratings agencies. Effective January 1, 2006, Fitch amended their stress criteria and is no longer the rating agency with the most constraining stress criteria.”

UBS, 2006

“Over the last year, each of the rating agencies has revised its criteria, making favorable changes to consumption forecasts, participating manufacturer market shares and stress scenarios, based on direct input from Bear Stearns.”

Bear Stearns, 2006

The Deal: $4.4 billion California “Golden State” Tobacco Settlement Bonds

“In fact, over the course of the last year, we have made major inroads with each agency. Bear Stearns renegotiated Moody’s criteria and increased leverage capacity by approximately 10% … Our negotiations to improve criteria and leverage capacity are ongoing …”

Bear Stearns, 2006

“In reality, we anticipate that the threat of not using Moody’s on a transaction of this size and importance could provide the necessary leverage to enable Moody’s analysts to get in-line with their competitors … UBS analyzed, re-engineered, and fundamentally changed the underpinning criteria for mainstream ratings when it first dropped Moody’s in conjunction with Kern County’s (California) transaction. After Moody’s agreed to fine-tune its stress test for the Kern County transaction, UBS presented similar reasoning related to the State of Rhode Island … As a result, Moody’s decided to permanently ease its stress tests ”

UBS, 2006

“…The rating agencies’ criteria for rating tobacco securitizations appears to be constantly evolving.”

Lehman Brothers, 2006

The Deal: $102 million Santa Clara County “Silicon Valley” Tobacco Settlement Bonds

“Though others viewed Moody’s as obsolete, UBS brought them back to the sector and worked with them to modernize their criteria … In 2006, Fitch announced that issuers could choose either the old or new stress methodology … UBS analyzed this new stress methodology and found that it offered no benefit to the municipal issuer at all … UBS shared its findings with Fitch within 24 hours of their press release. Fitch confirmed our analysis and worked with our tobacco securitization bankers to devise a new stress test methodology.”

UBS, 2006

The Deal: $5.5 billion Ohio “Buckeye” Tobacco Settlement Bonds

“In the past four years, (a Chase banker) has become known to the rating agencies as a reliable sounding board for new criteria (we invite unsolicited reference from the analysts to verify). … Negotiate Fitch to their knees to that they accept the securitization of revenues in the 41st year. This should be doable, and the Authority will have the ‘largest ever’ leverage."

JPMorgan Chase, 2007

The Deal: $197 million Rhode Island Tobacco Settlement Bonds

“Just last week, Moody’s indicated their willingness now to provide an investment grade rating on tobacco bonds with a nominal maturity of 45 years (rather than 40 years). In recent conversations with S&P, they indicated that they would most likely also extend to 45 years (subject to committee approval).”

Goldman Sachs, 2007

The Deal: $202 million Michigan Tobacco Settlement Bonds

“We view the current rating criteria relaxation for tobacco bonds as particularly interesting and unusual given current market conditions where the rating agencies are ‘under fire’ for rating criteria for structured financings, in particular CDOs.”

DEPFA First Albany Securities, 2008

“A one week rating turn around may appear aggressive, however, Citi has achieved such a time table on the two most recent tobacco bond transactions … the current schedule on the New York Tobacco Settlement Finance Corporation ($450mm) for which Citi is serving as a senior managing underwriter, calls for a one week rating process … Both S&P and Fitch have agreed to meet our aggressive timeframe.”

Citigroup, 2008

The Deal: $1.5 billion Illinois “Railsplitter” Tobacco Settlement Bonds

“One additional note in the context of today’s markets is the declining importance of the Rating Agencies. Although receiving an investment grade rating continues to be an important and gating item, the Rating Agencies have become less relevant and credible than before.”

Goldman Sachs, 2010
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