Bloomberg News

S&P AAA-Rated Notes Sold in Australia Decried as Junk

March 29, 2012

The Standard & Poor's Financial Services LLC logo is displayed outside of the company's offices in New York. Photographer: Scott Eells/Bloomberg

The Standard & Poor's Financial Services LLC logo is displayed outside of the company's offices in New York. Photographer: Scott Eells/Bloomberg

Standard & Poor’s, facing lawsuits by Australian towns for giving its highest rating to derivative- linked notes that lost almost all their value, should have known the investments didn’t deserve the ranking, an analyst said.

“It should’ve been junk,” said Peter Tchir, who developed collateralized debt obligation investments at Deutsche Bank AG and UBS AG before founding TF Market Advisors. “It’s good Australia is pushing this,” he said in a Bloomberg Television interview today.

The case, the first of its kind worldwide, claims S&P misled investors with its system for labeling a borrower’s creditworthiness, according to IMF (Australia) Ltd., which is funding the litigation. Twelve Australian townships as a group claim in their lawsuit that they lost A$15 million ($16 million) of A$16 million invested in notes called Rembrandt that were rated AAA by S&P. A 13th town sued separately after losing more than 90 percent of its A$1 million investment.

The towns claimed S&P gave the notes the highest investment rating after pressure from ABN Amro Bank NV, which became the Australian affiliate of Royal Bank of Scotland Group Plc. (RBS) ABN Amro Bank and S&P have denied the allegation.

The value of the so-called constant proportion debt obligations, created by ABN Amro Bank, was linked to movements in the iTraxx credit default swap index in Europe and the Dow Jones CDX in the U.S.

Second-Lowest Ranking

The assets backing the securities may have been worthy of BBB, S&P’s second-lowest investment rating, Tchir said. The notes used borrowing to magnify gains or losses, making them riskier, he said.

“Taking something that is BBB and leveraging it shouldn’t make it safer, but according to them it did,” Tchir said.

In rating the notes, S&P ignored lessons from the collapse of Enron Corp. and Worldcom Inc. in 2001 and the sudden changes in credit markets such events can create, he said.

Tchir said he hoped more investors would hold rating companies accountable, although U.S. free-speech laws protect the firms in that country from lawsuits such as the one filed in Australia.

The notes were unwound less than two years after the towns bought them as credit spreads increased, and their cash value was exhausted in 2008. Borrowing costs rose amid the most extreme financial conditions since the Great Depression, following the collapse of Lehman Brothers Holdings Inc., ABN Amro Bank said in written submissions.

The bank said it sold $5 billion of the CPDO notes and no one else sued, because most were sold to institutional investors able to properly assess the risks.

The Australian towns failed to make responsible efforts to understand the investment, S&P said in written submissions to Federal Court Justice Jayne Jagot, who will decide the case.

The case is: Bathurst Regional Council v. Local Government Financial Services Ltd. NSD936/2009. Federal Court of Australia (Sydney).

To contact the reporter on this story: Joe Schneider in Sydney at

To contact the editor responsible for this story: Douglas Wong at

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