Jules Kroll, a corporate investigations pioneer whose namesake firm once pursued hidden assets linked to dictators Saddam Hussein and Jean-Claude Duvalier, relishes the idea of chasing down the major bond rating agencies: Moody’s Investors Service, Standard & Poor’s and Fitch Ratings.
The industry needs a shake-up, he said. And he’s trying to provide one, founding the Kroll Bond Rating Agency in 2010 with help from his son, Jeremy.
“Six or seven years ago, I began to understand how some of the incumbents went about their business. I was always shocked and disappointed at the lack of diligence they undertook in a number of areas,” Kroll, the firm’s chief executive, said in an interview in his New York office. “I had a bird’s eye view of what was going on in companies that defaulted.”
Warning signs, he said, included the amounts of prepayments and increasing levels of default.
In 2008, just as Kroll was about to retire — he sold his original firm, Kroll Associates and later, Kroll, to Marsh & McLennan Cos. for nearly $2 billion in 2004 — the financial industry imploded.
“In March, Bear Stearns goes down. The subject of rating agencies came up and frankly, I was appalled at the absence of direct responsibility. With everything blowing up around me, I thought maybe there was a chance we could do it better,” said Kroll, who will turn 71 this month.
“Jules is an agent of change,” said Kroll Bond Ratings president Jim Nadler.
ASR interviewed Nadler in February 2011, when he told the magazine about Kroll's plans in the structured finance arena. To view story, click here.
The rating agency released its rating methodology for CMBS in June 2011, followed by RMBS in August 2011, and auto ABS in November 2011. Since June 2011, it has issued 10 structured finance ratings.
Kroll Bond Rating Agency has also received authorization to offer credit rating services to the National Association of Insurance Commissioners (NAIC) for capital purposes. As a result, the NAIC has added the agency to the Credit Rating Provider List.
In the municipal bond arena, Kroll and his small staff made waves six weeks ago when Kroll Bond Ratings issued its first rating to a state.
Kroll rated Connecticut’s general obligation bonds 'AA' — its third-highest ranking — with a stable outlook, matching the ratings of S&P and Fitch. Moody’s rates the GO debt 'Aa3'.
Kroll hopes to capitalize on investor disaffection with the three major agencies in the aftermath of 2008 global financial crisis, when credit agencies took the heat for bestowing triple-A ratings on mortgage-backed securities that soured.
“It’s okay to trust a triple-A again,” Kroll Bond Ratings trumpets on its Web site.
Drawing on his sleuthing background, Kroll, a Brooklyn, N.Y., native who grew up in Queens, cited an absence of surveillance on the part of the big three rating agencies, which control about 97% of the market.
Nadler worked for Fitch during its expansion phase in the early 1990s, rising to executive vice president. He sees both comparisons and contrasts with Kroll’s push.
“When I was with Fitch, the atmosphere was more benign. Investors wanted to see more information but they were not upset. One of the big differences today is that investors have lost confidence in the incumbent ratings agencies,” Nadler said.
Kathleen Kennedy, a senior director in charge of investor relations and marketing, cited Kroll’s depth of experience in a variety of sectors, “not just with rating agencies, but different backgrounds as well.”
For example, managing director Gary Krellenstein, who joined in November from JPMorgan’s energy and environmental group, issued a preliminary report about the difficulties of assessing the effects of Marcellus Shale natural gas drilling in assigning a municipal credit. Krellenstein called the development “a new dynamic in the market.”
The Securities and Exchange Commission has recognized Kroll as a nationally recognized statistical rating organization, or NRSRO.
Kroll, like the big three, is paid by issuers to provide ratings, according to documents it filed for its NRSRO certification.
In addition, Kroll has another investigative firm in its stable, K2 Global Consulting, to conduct much of the research for Kroll bond ratings.
Muscling in on the big three agencies, however, will be difficult.
“I think there is room, yes, but it’s going to be challenging for any rating agency to gain market share,” said Alan Schankel, a managing director at Janney Capital Markets in Philadelphia. “They’ll have to gain a reputation with analysts, both buy side and sell side.”
“Looking at Fitch and how hard they’ve had it is an example,” Schankel added. “Personally, I think Fitch puts out a high-quality product, yet they’re an also-ran when it comes to townships, for instance. That’s a lot of people you have to talk to.”
Moody’s and Fitch said they welcomed competition, while S&P said it does not discuss competitors.
“We believe that the market benefits from a diversity of opinions on credit, and we support healthy competition based on ratings quality,” said a Moody’s representative.
A Fitch spokesman added: “Investors should have access to a variety of credit opinions — that is good for markets.”
Kennedy, who is also a former Fitch operative, cited a conference in Las Vegas where one investor considered a Kroll presale report “a must read … the first thing I look to.”
She said the privately held agency has responded to investor feedback, such as a request to include executive summaries with reports.
“We’re owned by investors, so it makes sense to listen to investors,” she said.
Pension funds and foundations own 40% of Kroll Bond Ratings, according to the firm.
A partial list of investors includes Bessemer Trust Co., RRE Ventures, New Markets Venture Partners, value investor Michael F. Price, venture capitalist Frederick R. Adler, and power generation and transmission group LS Power.
Jules Kroll acknowledged what his firm is up against.
“Problems are good at presenting themselves,” he said. “We can’t be like the other guys. We always ask ourselves how can we do things better and how can we do them differently.”
One “legacy” challenge is systemic, according to Kroll and Nadler. The firm has been lobbying pension fund investors to broaden investment guidelines to include any NRSRO.
Historically, most investment fund guidelines require ratings — not merely reports — from Moody’s and S&P.
“It’s only good for the incumbents,” Kroll said. “It’s an impediment to anyone except Moody’s and S&P. It’s anticompetitive and very bad for investors.”
Kroll also cited the cost and time to adhere to all regulatory and compliance regulations “that have been implemented in good faith to correct the sins of the past.”
He also acknowledged a big intangible: “Just getting people to try something new."