Meredith Whitney, the former Oppenheimer & Co. analyst who famously predicted the banking crisis, announced last week that she plans to transform her boutique advisory firm into a nationally recognized statistical rating organization (NRSRO) that will rate muni and other kinds of debt and compete with Standard & Poor’s and Moody’s Investors Service.
Whitney, whose firm Meredith Whitney Advisory Group currently offers credit ratings to her subscribers, told the Financial Times that the existing NRSROs are no longer credible given the triple-A ratings they frequently bestowed on securities that turned out to be worthless.
“Our system is far more transparent,” she said. “The credibility is far greater on structured products, corporate products and now municipal products.”
Whitney generated headlines in September when she released a voluminous report to her subscribers that warned states are likely to default on their bonds and other obligations and require massive federal bailouts. Though widely discussed, the report was never made public and has been dismissed by many muni market participants. Whitney is a bank analyst by training, not a muni credit analyst.
But Whitney said in media interviews that she spent over two years researching the municipal market for the report and was alarmed by what she found.
A spokesman for Whitney said she was traveling and unavailable for additional comment Friday. In her interview with the Financial Times, Whitney said obtaining NRSRO recognition from the SEC would allow her firm to significantly scale up in size and transition to an issuer-pays model.
She said that subscribers are never going to pay enough — or as much as issuers — to allow her to afford a team of quality analysts.
But the likelihood of Whitney launching a successful issuer-pays-based NRSRO raises its own questions. If Whitney seeks to rate state and local government debt with a more skeptical eye than the existing rating agencies, why would an issuer want to pay for her ratings?
“She hasn’t started off on the best foot,” said Matt Fabian, managing director at Municipal Market Advisors. “The market largely dismissed her report. I can’t imagine people taking her seriously, so it’s going to be an uphill battle.”
There is not a need among municipal market professionals for another rating agency, he added.
“Moody’s, S&P, and Fitch Ratings together have done a pretty solid job,” Fabian said, noting that of the 270 credits in payment default right now, only 21 of them were initially rated. “So even in the worst economic crisis that most of us have ever seen, rated bonds are holding up extremely well in this sector.”
“When it comes to municipal bonds,” added Richard Larkin, senior credit analyst at Herbert J. Sims & Co., “she did a lot of work but she really doesn’t know what she’s talking about.”
Finding market acceptance isn’t the first need, either; receiving accreditation is, and Whitney would need to overcome more than the usual obstacles to obtaining NRSRO status.
“Getting an NRSRO accreditation is very difficult — it takes years,” Fabian said.
Because she started her firm just last year, Whitney would need an SEC exemption from a provision in the Credit Rating Agency Reform Act of 2006 that requires a credit rating agency to have been in business for at least three consecutive years before it can be recognized as an NRSRO.
The SEC has agreed to exempt two NRSROs — Realpoint LLC and LACE Financial Corp. — from another provision in the law designed to curb conflicts of interest, though it ultimately was burned for doing so in LACE’s case.
In 2008, it granted LACE, a subscription-based credit rating agency based in Frederick, Md., an exemption from a provision that prohibits an NRSRO from issuing or maintaining a rating solicited by a client that has provided it with 10% or more of its net revenue in any fiscal year.
However, in September, the SEC censured and fined LACE $20,000, largely for downplaying the amount of revenue it received from its largest customer during 2007. It said in SEC filings that its largest client accounted for 14.2% of its revenue that year, when it actually accounted for about 28%.
Just before the SEC’s cease-and-desist order, LACE’s founder sold the firm to Kroll Bond Rating Agency Inc., reportedly for more than $5 million.