After experiencing a barrage of criticism for their tardy downgrades, the top three ratings agencies are seeking to regain credibility by tailoring their research efforts to better meet the needs of investors.
These moves include structured finance and ABS research. Meanwhile, competitors, smelling weakness, are plotting to expand into their turf.
The collapse of the credit markets in 2008 took a big toll on the reputations of the agencies, which, at times, downgraded 'AAA'-rated structured and ABS debt several notches, but only after the problems were apparent for all to see.
The vast majority of market participants, however, were caught by surprise when credit fell off a cliff. Edward Atorino, an analyst who covers Moody's Corp., parent of Moody's Investors Service, and McGraw-Hill Cos., which houses Standard & Poor's, said criticism has often misinterpreted the role of the agencies.
"What they try to do is say, 'Based on the data we have and what we get from the loan originators, these are estimates of what could happen,'" Atorino said, adding, "Anything the agencies can do to explain what they actually do, what their responsibilities are, and what their goals are, is helpful."
Atorino noted that McGraw-Hill has proactively sought to inform investors about inaccuracies portrayed in the media about the role the rating agencies play. The firm's investor relations department has sent alerts to investors to correct such inaccuracies, while CEO Terry McGraw has noted on the conference circuit the firm's successes in having investors' suits against it dismissed.
Nevertheless, the estimates produced by the rating agencies' credit models clearly failed to warn investors about the impending disaster. To help rebuild their reputations, each of the three large agencies has initiated efforts to more effectively package and distribute their data and analysis to institutional investors. The intent is to enable investors to better form their own credit outlooks and give them more transparency into the ratings analysts' thought processes.
Whether the agencies, which rate transactions worldwide, succeed in fully re-establishing their credibility remains to be seen. Smaller competitors, such as DBRS and Realpoint, which was acquired in May by Chicago's Morningstar for a hefty $42 million in cash, see their larger brethrens' weakened state as an opportunity to capture market share.
"Part of the challenge the [top three] agencies face is having to regain credibility, and I don't know whether their efforts will be enough," said Rob Dobilas, the CEO of Realpoint who founded the firm in 2001 as a division of GMAC's commercial mortgage unit.
In fact, the credibility of the rating agencies was so marred that the National Association of Insurance Commissioners (NAIC) decided in fall 2008 to explore becoming a nationally recognized statistical rating organization (NRSRO). That designation, held by 10 or so firms, allows an agency to issue credit ratings that other financial institutions can use.
An NAIC spokesperson said that, given the potential costs and uncertainties around establishing a rating agency, and the currently heightened scrutiny of the existing agencies, NAIC determined "the effort will not be pursued at this time."
That's one less potential competitor to worry about. However, if Dobilas is correct - and he's clearly not an impartial observer - Realpoint's subscription-based ratings model, compared to the larger agencies' issuer-driven fee model, might gain significant traction.
To counter competitors, each of the large rating agencies has recently created units - some staffed by analysts with long experience on the sell side - to effectively present and distribute their firms' data and analysis to investors.
S&P's, for example, announced at the start of June hiring Howard Esaki as a managing director and head of a new global structured finance research department aiming to produce research that's complimentary to but separate from the firm's ratings analysis.
Esaki worked at Morgan Stanley for 15 years, most recently heading its CMBS research efforts in Tokyo and London, and previously he ran the mortgage research team at Moody's and served as economist at the Federal Reserve Bank of New York. Esaki said his group may dig into research topics on its own, but its main goal is to "leverage" the research already generated by the ratings agency.
"S&P does a lot of good research already," Esaki said, adding that his group's goal will be to publish it in a more timely and routine fashion, as well as to push the ratings analysts to examine trends across asset classes and geographies. Perhaps most important will be getting out the message about S&P's resources to the investor community.
Besides more frequent electronic communications about what's available and commentaries, Esaki said, he and his staff-most likely comprising a few people in each geographic region-will join ratings analysts in face-to-face meetings with investors.
"When an analyst writes a piece, we'll go out to talk to investors about it. I know a lot of people in the investor community, and my goal is to distribute our research to a wider audience," Esaki said.
Douglas Lucas, an alum of UBS and JPMorgan, where at each firm he headed up CDO research, was hired by Moody's in November 2008 to hone the firm's research products, in an effort to provide more in-depth analysis to investors.
Lucas has been charged with that task across all of Moody's research, and in April he hired Andrew Jones, who was previously from DBRS, to focus on structured products.
"My role in part is to be a coach, and to assist from idea generation to formulating the message and then to writing an insightful and meaningful report. Rather than hire professional writers, we want to train these experts (the ratings analysts) to be better communicators," Lucas said.
Lucas and Jones don't anticipate meeting up with investors in the process of delivering their research products, leaving that to the ratings analysts. Lucas, however, has been busy organizing the rating agency's resources to publish regularly newsletters aimed at providing investors with detailed analysis about specific topics. Structured Thinking: Asia Pacific and Structured Credit Perspectives, for example, were launched earlier in June. The first issues of Credit Insight: European ABS and RMBS and Resi Landscape, covering the U.S. RMBS market, came out respectively in November and August of 2009.
David Weinfurter, a managing director at Fitch Ratings, said that the rating agency has recently created "dedicated" research groups - in a similar vein to Moody's and S&P - in areas such as financial institutions and nonfinancial corporates. Another unit, created earlier this year, looks across the firm at different regions and types of assets, and focuses on macro issues.
Lucas acknowledged the challenges the credit rating agencies face to rebuild their credibility. "We can't change what happened in the past, but we can do a much better job of getting out insight and intelligence about credit issues to investors," he said.
He added that Moody's has also staffed new positions internally to bolster its surveillance of existing transactions.
In fact, the large credit rating agencies have been roundly criticized for focusing on rating new deals and lax surveillance of existing ones. Realpoint, instead, has built its business around monitoring the performance of domestic CMBS deals, and only began rating new deals - after receiving its NRSRO designation - in 2009. It examines loan-level data and highlights risks associated with deals every month. Over the past two and a half years, it claims it has been ahead of the top three agencies by an average of five to six months on half the reported ratings actions.
Dobilas describes his competitors' new research initiatives as "attempts to play catch-up to develop products and services focusing on investors."
Realpoint, however, covers only domestic CMBS deals, whereas the top three agencies rate all manner of debt across the globe, and therefore can provide research-especially on the macro front-that's simply unavailable from smaller competitors.
DBRS, which received its NRSRO designation in 2003 and expanded quickly into the structured finance and ABS arenas, also rates a wide variety of debt instruments.
Larry White, managing director of business development, said the firm will continue to rely on its ratings analysts to produce in-depth research and provide "high-touch" customer service, and it has no plans to create research-only positions. The firm has rated European transactions for a few years, and now it plans to reopen its office in London.
Realpoint also has aspirations to expand, overseas and into other structured asset classes. "We think there's an immediate need for investors to have an investor-based service for RMBS, so that will be the first one," Dobilas said, calling the initiative "definitely slated for next year."
Various ABS asset classes are also on the drawing board, as is overseas expansion-moves that should benefit from its acquisition by Morningstar.
Catherine Odelbo, president of equity research at Morningstar, said Realpoint and Morningstar's corporate credit rating group will remain independent business units.
"At the same time, Morningstar will contribute 25-plus years of experience, stability, credibility, and resources that will allow Realpoint to continue to develop its business internationally and across many sectors of the market," Odelbo said.
