Valuation Awakening - Does the Emperor Have Clothes?
A mystery is unfolding. How can securities receive robust credit ratings and then turn out to have questionable value? Isn't there supposed to be continued oversight vis-a-vis an issuer's ability to pay? In "Moody's CFO sued over bond ratings; Firm gave too high ratings to sub-prime bonds," Business Times Singapore reports on a class action complaint by a private investor. Alleging that the CFO "failed to disclose that Moody's assigned 'excessively' high ratings to bonds that were backed by sub-prime mortgages," traders are now betting that additional suits against other rating agencies will follow. While a complaint in no way attaches guilt to the defendant, it will be interesting to learn more about the sub-prime bond ratings process if these cases proceed. (Some organizations post information on the website.)
Reuters reporter Neil Shah discusses some pitfalls when complex securities are "marked to model," including unrealistic assumptions that can skew results. "The worry is that well-heeled hedge funds, Wall Street proprietary trading desks and ratings agencies may be too optimistic when analyzing or valuing exotic mortgage investments. As a consequence, future drops in market prices may be more severe and possibly trigger panic selling by sophisticated investors." (Click here to read "Can Wall Street be trusted to value risky CDOs?" July 16, 2007)
As investors wait for the other shoe to drop, readers are reminded that process is everything. Unless a plan sponsor is prepared to ask tough questions about how an asset manager values the portfolio and components thereof, it may be a redux of "The Emperor Has No Clothes." Worse yet, individual fiduciaries could be exposed to allegations of breach for failure to effect proper due diligence." As an Accredited Valuation Analyst, my appraiser colleagues would no doubt concur with me. Valuation is a specialty and not to be taken lightly. As markets tank ("worst fall in nearly five months" on July 24) plan sponsors may find themselves in an uncomfortable double whammy position - plunging prices of traded equities and difficulty in unwinding "hard to value" instruments. (See "Markets tumble as credit concerns spread" by Michael Mackenzie and Saskia Scholtes, Financial Times, July 24, 2007)
Though written in 2004, "Asset Valuation: Not a Trivial Pursuit" by Dr. Susan M. Mangiero is still worth a read. Click here to download the article. (You can sign up for a free 14-day trial subscription and access the article for no charge.) Drop us an email if you want to know more about our training in the areas of risk and valuation for trustees, board members and investment committees. All inquiries will be kept private.
