The financial crisis reached its apex in fall 2008 when major Wall Street firms collapsed. But for the big three rating agencies - Moody's Investors Service, Standard & Poor's and Fitch Ratings - the crisis began at least a year before, when they started issuing massive downgrades of RMBS.
Those downgrades were often multiple notches - some from high investment grade all the way to non-investment grade - leading critics to decry the ratings system as broken.
Troubles for incumbents can often benefit up-and-comers, and at least two are jumping into the structured-finance-ratings game. Kroll Bond Ratings bought LACE Financial last August to acquire its designation as a nationally recognized statistical rating organization (NRSRO), and ratings star Meredith Whitney's firm is aiming to do the same.
Morningstar's Realpoint ratings unit has long provided structured-finance analysis to investors on a subscription basis; it issued its first CMBS new-issue rating in late 2009 and plan to begin rating RMBS later this year.
A more seasoned if still a relatively new kid on the block is Toronto-headquartered DBRS, which recently has found success generating ratings in areas that the big three have dedicated fewer resources to as they pay closer scrutiny to existing ratings and adopt internal reforms.
"We see opportunity where we notice other agencies don't have dedicated resources or are not specifically focused, or we have analytical capability we think we can bring to bear," said Jerry van Koolbergen, managing director at DBRS responsible for U.S. and European structured credit rating analytics. "We're a midsize company and we're not aiming to be the size of Moody's, S&P or Fitch."
DBRS's approximately 100 analysts - compared to more than 1,200 at Moody's and S&P - focus on rating structured finance, financial institutions and sovereign ratings. One opportunity that has grown from the financial crisis is rating the restructurings of distressed structured financial assets, such as CDOs of ABS and/or RMBS.
"My team has been rating those products for years and we have a different approach to those ratings," said van Koolbergen, who, prior to DBRS, was a senior CLO and CDO structurer at JPMorgan and Morgan Stanley for a total of eight years. "The other agencies have rightfully been more focused on the performance of their ratings on the underlying assets that went into those CDOs."
Those jobs may arise when an institutional investor is considering a restructuring of structured products it owns. "We can analyze the underlying assets in a granular way and assign a rating to a proposed restructuring," Van Koolbergen said. "Quite often it's not the answer the investor initially expects, but it's an honest analysis of what we think the potential rating might be."
Those ratings are usually public, and the restructurings are typically bespoke and investors pay the bill. For new-issue ratings, issuers receive the invoice. Van Koolbergen said a major strength of DBRS when competing against the big three is the firm's nimbleness and ability to produce ratings quickly. "Where we find a lot of traction is the transparency of our methodology and our services, and the timeframe in which we're able to produce answers because we're smaller and have a flatter decision making structure."
Transparency has become a buzzword in the rating agency community, and the big three have all taken steps to shed light on their ratings processes. Those agencies have also taken numerous other steps-unbeknownst to many investors who have faced more pressing concerns such as last May's flash crash - to rebuild their ratings integrity (see sidebar).
DBRS makes some of its analytics, such as its CDO Toolbox, available to clients on its Web site. However, the firm prides itself on making its analysts, who also develop the analytics supporting the models, immediately available to answer investors' questions in detail. Van Koolbergen said that a long-term goal is to put more of its analytical models online.
Since DBRS ratings analysts develop the models and methodologies they later apply to rate assets, the firm's policy department reviews their new methodologies. "So we have the analysts most familiar with the assets proposing the methodologies, and then our separate policy function reviews and signs off on them," Van Koolbergen said.
Once those steps are completed, the firm's criteria committee, comprising senior members from across the firm, reviews the approved methodology. If it raises questions or concerns, the process begins again. "Typically methodologies will go through more than one iteration of policy approval and criteria committee review," Van Koolbergen said.
DBRS's U.S. and European units, which work closely together, only began rating structured assets in 2007, shortly before Van Koolbergen joined the firm. And so it avoided much of the structured-credit ratings "instability" that plagued the big three agencies, when their existing ratings plummeted. In addition, said Van Koolbergen, the U.S. book of DBRS structured credit ratings consists mostly of ratings on bespoke structured credit transactions, and those have performed "very well."