Leveraged loan investors are in an uproar over the fees they pay to obtain a credit estimate — a private rating on an individual loan — from Moody’s Investors Service.

Some claim Moody’s has deliberately refused to issue a public rating — one that the issuer pays for and everyone can use — in order to obtain higher fees by charging investors individually. Moreover, investors are furious because, they say, they have to pay the fee each time they place a loan in an additional investment vehicle.

“As an investor, I subscribe and pay quite hefty fees to obtain credit research and ratings that are a result of the rating agencies analysis of the various issuers that I purchased,” said Deborah Cunningham, an executive vice president at Federated Investors and co-chair of the Securities Industry and Financial Markets Association’s credit rating agency task force. Cunningham made her comments at a recent Securities and Exchange Commission (SEC) roundtable on the rating agencies, which addressed a range of topics, including how rating agencies collect fees from individual lenders.

Her comments were mild compared to what other investors had to say on the matter. “It’s a racket pure and simple,” said a New York-based loan trader. “Call up a big CLO equity player who has cash in 50 different funds and see how he feels about essentially paying $250,000 to have one private rating.” The charges vary depending on the credit, but a single rating on a loan can run as much as $5,500, sources say.

It’s difficult to track how much this has taken place recently due to the opaque nature of these private ratings, sources say. The most definitive example happened with the $8 billion DIP for Dutch chemical maker LyondellBasell. UBS, one of the arrangers of the DIP, has received numerous complaints from CLOs because Moody’s obligated each lender to pay a fee in exchange for a credit estimate on the loan, according to an email exchange between one of the DIP lenders and one of the other agent banks on the deal. Calls to UBS and Lyondell were not returned.

He added that there are nearly 500 lenders in the consortium, and at $5,500 a pop that’s more than $2.7 million collected in fees. Sources say Moody’s typically receives roughly $250,000 for a publicly rating a loan.

“The most absurd thing about [these investor-based fees] is that there is a charge for each rating,” a CLO manager said. “Let’s say [our firm] asks for a rating, and we have 10 vehicles we want to put that loan in. We have to pay the fee, whatever that amount is, 10 different times, rather than just paying once to use a rating for all the entities.”

Moody’s, for its part, denies that it charges CLO managers for each use of a credit estimate.
“CLO managers occasionally wish to add unrated debt to their portfolios. In order for Moody’s to rate these CLOs, Moody’s policy is to assign a credit estimate to this debt,” Thomas Lemmon, a Moody’s spokesman, said in a statement. “Moody’s charges a fee to assign a credit estimate, and a CLO manager can then use this credit estimate for as many managed deals as they wish without incurring an additional fee. Additionally, Moody’s charges CLO managers a modest annual monitoring fee for these credit estimates. These credit estimates are not ratings. Moody’s will publish a public rating on the debt only at the request of the issuer.”

This issue has fallen right into Moody’s lap because the firm is, as one source put it, “the lead criteria” used by structured vehicles, such as CLOs, for assessing the credit risk of a certain loan. Another factor making Moody’s unique is its WARF test. A WARF, or weighted average rating factor, is used to asses the risk of the underlying credit quality of assets in a structured vehicle.

Credit estimates on individual loans are vital to CLOs because they are required to maintain a certain mix of rated debt. And they have to obtain a new credit estimate on the loans they carry each year.

“[Moody’s] certainly has a razor-razor blade business going on. The razor being the CLO and the razor blades being individual ratings that have to be updated once a year,” the CLO manager said.

A New York-based investor added, “[Moody’s] realized that CLOs have no recourse but to pay. These fees drain cash that is available to pay debt and equity distributions.”

CLOs are not the only ones affected by these fees. Other loan investors, like those who manage closed-end loan funds or separately managed accounts, need the ratings to meet their own fund requirements or because they need to show they have received an objective, third-party analysis of what they’re investing in.

Moody’s has been charging individual investors like this for years, and these fees have always been an issue with investors. However, they have become more of a burden because of the recession.

And Moody’s is making matters worse by moving away from its issuer-driven model and putting more of the burden onto investors, sources say. They say the rating agency is doing this because it can collect higher fees from individual investors.

To be fair, this does leave rating agencies with a bit of a rock-and-a-hard-place dilemma because some regulators, national business associations, corporate executives, professors and analysts have pointed out that there is a conflict of interest with the issuer-driven fee model. And many have advocated moving away from it. Moreover, sometimes a company chooses not to obtain a public rating thereby handing the fee over to investors.

“Unfortunately, the current credit rating agency processes are not sound or reliable. In our view the system is broken,” said James Kaitz, president and CEO of the Association for Financial Professionals

At the recent SEC-sponsored roundtable on rating agencies, Kaitz proposed an alternative to the current fee model. He suggested that the agencies implement a model that is similar in nature to a utility company. Firms like Moody’s, he said, could be financed by transaction fees that could be equally spread out among issuers and investors. “Under this model, conflict of interest issues that currently exist would be mitigated,” he said.

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