AMID THE EUPHORIA OVER THE success of the country?s first automated elections, credit rating firms Standard & Poor?s and Moody?s Investor Service said the other day their appraisal of the Philippines? creditworthiness remained unchanged.

They have given it a BB-minus or Ba3 rating, or three notches below investment grade. Meaning, there is a strong possibility that, considering the country?s budget deficit and low tax collection, it may be unable to promptly pay its existing loans.

Credit rating companies are engaged in the business of reviewing the financial condition of persons or corporations that apply for credit with banks and other financial institutions.

Depending on their evaluation, they rate the capability (or inability) of prospective debtors to meet their obligations in accordance with the terms and conditions of the loan agreement.

A rating below investment grade (or AAA) should?in theory?put the creditor on notice about the probability of default by the borrower.

With this red flag, the creditor can refuse to lend the money, or take preemptive protective measures, such as, impose higher interest, demand additional collateral, or control the disposition of the borrower?s earnings.

Connivance

When the United States economy was crippled in 2008 by the collapse of its subprime housing mortgage system, several US-based credit rating companies were accused of complicity in the mess.

Despite the poor credit standing of the mortgage holders, these companies gave ?investment grade? ratings to financial instruments or securities issued by investment banks over these mortgages.

The favorable rating enticed the public, including banks, pension funds and other financial organizations that should have known better, into buying these securities.

The credit rating companies, whose profits depend on the fees they collect from issuers of securities they are asked to rate, were criticized for gross negligence and conflict of interest.

It was a classic you-scratch-my-back-I?ll-scratch- yours arrangement. In consideration for substantial fees, AAA ratings were given to the instruments regardless of their credit quality.

Caught with their hands inside the cookie jar, the companies raised the defense, among others, that they merely gave their opinions about creditworthiness and that it was up to the public to accept or reject them.

Securities

After two years, the credit raters are being made to account before a US court their liability, if any, over securities they held out to the public as good investments but later turned out to be lemons.

Earlier this month, a California court gave the go signal to hear the suit for damages filed by the largest US pension fund, the California Public Employees? Retirement System (CalPERS), against S&P, Moody?s and Fitch Ratings.

The case involves securities worth $1.3 billion that CalPERS bought from two companies engaged in the sale and purchase of securities.

The securities consist of various loans and mortgages, including those held by people who did not have the capacity to pay their loans, that the two companies bundled as a separate instrument and offered to investors.

These securities, which go by the names ?collaterized debt obligation,? ?structured investment vehicles? and other exotic descriptions, basically involve a promise to give investors a proportionate share in the payments to be made by the people behind the loans or mortgages.

CalPERS said the securities in question received ?triple A? ratings from the three credit rating companies.

When the housing market suffered heavy losses starting in 2007 culminating in the September 2008 financial meltdown, CalPERS was stuck with worthless securities.

Losses

In its suit, CalPers argues that those ratings ?were wildly inaccurate and unreasonably high? or did not reflect the true creditworthiness of the loans and mortgages that underlay the securities.

The pension fund, which provides for the retirement benefits of 1.6 million public employees in California, claims to have incurred $1 billion in losses.

The three credit rating companies are also in the carpet in other US courts for fraudulent credit rating activities involving securities issued in connection with toxic housing mortgages.

The squeeze has further tightened with the recent move by the US Department of Justice to investigate the use by Moody?s of certain credit evaluation procedures that could give rise to criminal liability.

If the probe comes up with damaging evidence, the responsible officials could face criminal raps with stiff prison terms.

Understandably, the credibility of credit rating companies has come under scrutiny in the wake of the legal mess they presently find themselves in.

Can their ratings be trusted to reflect the debtor?s true credit standing?

Does the amount of fees charged for the rating work influence the credit rating given? Whose interests should they protect? Their client-companies, or the investors who look to their rating for guidance?

Next time you read about credit ratings, take them with a grain, if not, tons, of salt.

(For feedback, please write to rpalabrica@inquirer. com. ph.)