The financial crisis of the last couple of years has brought to the fore the shortcomings of the major credit rating agencies.
The failings of the big three have created space at the table for others, including the Horsham, Penn.-based Realpoint, a credit rating agency that rates CMBS.
After being granted the Nationally Recognized Statistical Rating Organization (NRSRO) status necessary to rate new bond issuance (the status is now held by 10 companies), Realpoint has recently gained recognition on some other regulatory fronts as well.
In September, Realpoint ratings were approved by the National Association of Insurance Commissioners (NAIC) for use by life insurance companies in gauging capital strength and reserve requirements. Realpoint ratings are also deemed acceptable for purposes of the Term Asset-Backed Securities Loan Facility (TALF).
New Kid on the Block
Realpoint was initially set up in 2001 as a division of GMAC Commercial Holding Corp. to provide surveillance in the CMBS space.
Robert Dobilas, Realpoint president and CEO, and a former associate in Standard & Poor's real estate group, noted that there was an opportunity. "Whereas the big three rating agencies were all tied up fighting over new issuance, nobody watched the store," Dobilas said.
The company was bought out by its senior management in 2007 after GMAC Commercial Mortgage, now Capmark Financial, was sold to private equity investor KKR, considering that the unit did not fit in with the futureplans for GMAC.
Realpoint prides itself on providing a dynamic update as market-sensitive events unfold, rather than sticking to a review timetable. "What distinguishes us most from the other agencies is our attention to detail and the timing with which we go to market with that information," according to Frank Innaurato, Realpoint managing director.
The NRSRO designation will also help Realpoint compete on the new issuance front. "We didn't like the traditional rating agency business model," Dobilas said. "They were competing in an industry with little evolution. They were providing analysis that was inadequate at best, and investors were looking for more. And we think that we bring a lot to the table."
Overreliance on Ratings
The major rating agencies have not had the best track record, said Hampton Finer, deputy superintendent and chief economist, New York State Insurance Department. This is one factor that led to the NAIC's recent approval of Realpoint CMBS ratings.
The broadening of the pool provides more choice for life insurance companies. Moreover, considering that Realpoint has a subscriber-paid model whereby investors pay for rating opinions, that's another advantage, according to Finer. Besides, Realpoint tends to update their ratings more frequently than the others.
In the short run, though, Finer expects that there will not be much of an impact from the inclusion of Realpoint. "But over time it will be beneficial. We will get more precise credit ratings and a more precise capital model as a result of their inclusion," he noted.
Even then, NAIC would like to eventually move away from reliance on rating agencies altogether. The regulatory authority is in the process of approving a proposal to use modeling provided by an analytical firm, such as BlackRock, to establish expected loss on securities.
This sort of model would serve to set up capital requirements for insurance companies without relying on credit ratings. This framework will be first implemented for the RMBS space by year end, and may later be extended to the CMBS and ABS space.
"We held hearings on rating agencies. There is a clear message from most of the people that testified, including the rating agencies themselves, that there has been an overreliance on ratings by regulators," Finer said.
He added, "We took that very seriously, and we're looking at ways of reducing our reliance on a small group of rating agencies using as many tools as we think are practical and good."
Leveling the Playing Field
Dobilas pointed out that the big three rating agencies now have 90% of the market share. "New firms that come into the space will find it difficult to compete head-on given the lobbying power these firms have and the tight hold they have with the issuers," Dobilas said. "The real key is to dilute the power."
The Securities and Exchange Commission (SEC) has also taken recent action to level the playing field by providing access to information necessary to rate securities to all NRSROs, not just the ones issuers are considering hiring.
Realpoint has also come up with proposals to move away from the current business model. For instance, they would like the SEC to choose one of the rating agencies involved in rating a deal, with the issuer free to choose the other one.
In the current system, the rating agencies earn the bulk of their revenues from ratings of new bond issuances for which they are paid by the issuers of the bonds. This means that the rating agencies have more of a motive to please their clients, the issuers, rather than the investors that actually rely on the ratings.
Tony Butler, co-head of RAIT Securities' Charlotte, N.C.-based advisory business, pointed out, "If you are missing out on deals and if you are trying to win a mandate, you can either lower your fees or come back with favorable (subordination) levels. If you can't win on either of those, then you will not be around. If you win on one or the other, that may or may not have implications for how the ratings work."
Butler sees the broadening of the competitive space as a move in the right direction. Among other shortcomings, overreliance on the big three has introduced a certain amount of volatility to the marketplace.
Citing a recent instance of S&P actions, Butler said, "They came out with one statement (in April), and seven weeks later they basically reversed themselves and started downgrading wholesale. That about-face heightened the need for the insurance companies to have another rating agency out there in order to combat that (volatility) for their capital purposes."
However, whether there is going to be any real fundamental change in the rating agency business model remains to be seen.
Butler noted, "Going forward, for new issues it will be interesting to see how this (additional competition) plays out. Generally, more competition is better than less, but unless the agencies answer to the investors, you could have the same old game going on again."
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