Kroll Bond Ratings is set to publish its initial rating criteria and research for structured finance at the end of February, according to James Nadler, president and chief operating officer at the company.

Nadler said that Kroll plans to rate basically all types of structured finance deals, although it will have a specific focus on RMBS, non-consumer ABS and single-borrower CMBS.

The rating methodology and research that Kroll will publish in February will probably be on its CMBS criteria, a sector that Nadler said seems to have "picked up a bit."

Currently the firm has 10 structured finance experts, and it is continuing to add staff in this area.

The firm's initiatives on the structured side are set to be followed by ratings for public finance issuers later this year and corporate issuers in 2012.

Kroll acquired its designation as a nationally recognized statistical rating organization in August when it acquired LACE Financial. The agency was founded by Jules Kroll, who in 1972 established Kroll Associates, an investigative and corporate security firm. He ran the company for 34 years and sold it to Marsh & McLennan in 2004.

Nadler said that his firm is "beginning to get traction as our message of investor focus" gets across. He outlined Kroll's four-pronged approach to rating transactions: increased due diligence; greater transparency in terms of the analytics it uses and how it arrives at a rating; better post-issuance surveillance; and more accurate ratings.

It is a matter, he said "of being interested and being willing to talk about the failures of the past, and how to do things differently." Nadler added that it is important to listen to investors' concerns.

"We are trying to have better follow-up with investors by providing them with timely and accurate information," Nadler said. "You have to simply align yourself with their interests and serve as a conduit of information for investors to and from the capital markets. By creating a dialogue with investors regarding your rating information, they will want to hear what you have to say as a result."

 

Changing the Paradigm

"We want to change the paradigm," Nadler said. "We want the rating agency to do what it was originally intended to do - and that is to be a voice for investors."

The rating agencies forgot that purpose and devolved into "a monolithic business that pays no attention to its ultimate constituents," he added.

The agencies have been criticized for assigning ratings that proved to be too optimistic as the meltdown in the market for MBS helped spark a worldwide financial crisis.

Nadler knows the rating agency world from experience. He began his career as a ratings officer with Standard & Poor's, and from 1989 to 2001 he worked at Fitch Ratings, where he was an executive vice president and led the structured finance group.

Nadler then co-founded Criterion Research Group, an independent firm that was sold in 2006.

He spent the last four years on the buy side at General Re Corp., the reinsurer owned by Berkshire Hathaway, before moving to Kroll in August.

"I have a fresh and real understanding of what investors want and what they need," Nadler said. "Most investors don't have a staff of 100 people to look at all these bond issuances. They need information from various sources, and the rating agencies are one of the main places they can get information."

The subprime mortgage crisis, however, revealed some fundamental problems at the rating agencies and created an opening for some new competition.

Jerome Fons, executive vice president at Kroll, wrote in late 2010 that the crash of 2008 "poured discredit onto rating agencies that has yet to be dispelled."

Fons, formerly a managing director of credit policy at Moody's Investors Service, where he worked from 1990 to 2007, criticized the rating agencies for lacking transparency, due diligence and good governance.

Another key is providing better post-issuance surveillance, an area that Fons said was "noticeably missing" before the financial crisis. That surveillance creates a feedback loop to incorporate new research and rating methods.

LACE, the company Kroll acquired in August and renamed in December, currently rates 20,000 financial institutions, including "virtually every" commercial bank and credit union in the country, Nadler said.

Kroll will operate with an issuer-pays model for structured finance products, public finance bonds and corporate debt. Nadler said that this model benefits investors that do not have the financial resources to pay for a significant amount of deal information that they need.

The company also benefits from the fact that the operations it inherited from LACE operate independently, offering quarterly updates to paying subscribers.

Partly owing to that relationship, Nadler said Kroll has the resources to develop a better relationship with investors than competing rating agencies.

"There's an opportunity there for more and better due diligence," Nadler said. "That's really in our DNA."

 

Other Markets

The public finance market offers the biggest opportunity for the new agency after structured finance products, Nadler said.

In both instances, the company believes it can add value by developing a deep relationship with investors and adding "meaningful commentary" to the marketplace.

"Kroll does a good job on interdisciplinary things, where you take a view from different areas," Nadler said. "You may take some information from the structured side or the corporate side, and because we are small and nimble, it's easy to put in an interdisciplinary group."

Kroll is moving more quickly than originally anticipated to rate municipal bonds because of a growing relationship with startup bond insurer BondFactor Co., a company executive said.

Brad Wendt, president of BondFactor - which also seeks to enter the market this year - confirmed that the new insurer has been in talks with Kroll, as well as with S&P and Moody's, to seek a rating. Fitch is no longer analyzing bond guarantors.

BondFactor seeks to insure municipal bonds using a pooling method described by some as "a muni-collateralized debt obligation."

The structure comes naturally to Kroll, Nadler said, because it requires analysis from people with knowledge of structured finance as well as public finance.

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