LO 36.3: Explain the im plications o f credit ratings on the emergence o f subprime

LO 36.3: Explain the im plications o f credit ratings on the emergence o f subprime related m ortgage backed securities.
Assigning credit ratings for securitized assets presents additional challenges. Credit ratings for subprime securities, and more generally asset-backed securities (ABS), differ from corporate ratings in several important ways. First, corporate bond ratings are based on the firm-specific characteristics of the issuer where as ABS is a claim on a portfolio. Hence, systematic risk and degree of correlation between assets is important in the latter but not the former. ABS represents claims on a static pool and cannot infuse additional capital or restructure as a corporation can. In addition, the forecasts for ABS incorporate future economic conditions since the cash flow stream is tied to the macro environment. Finally, while corporates and ABSs with the same rating may indicate similar default probabilities, the ABS will exhibit much wider variation in losses.