Meredith Whitney, a Wall Street analyst who shot to prominence with bearish calls on banks before the financial crisis, plans to set up a credit-rating agency to go head to head with Moody’s Investors Service and Standard & Poor’s.
Meredith Whitney
Ms Whitney said in an interview with the Financial Times that her new agency would use the same business model as established agencies, in which issuers of debt pay for ratings. She maintained that she would be able to manage potential conflicts of interest, saying: “If you run a good business and you have compliance in place, there should not be problems.”
Indeed, the huge amounts of debt financing and refinancing activity that has been going on this year in the capital markets, particularly in the US bond markets where interest rates are at record lows, have boosted revenues for the biggest rating agencies. Bond sales by companies with “junk” or “high yield” ratings, for example, are higher this year than they have ever been before.
S&P, owned by media company McGraw-Hill , had its highest earnings of the year in the last quarter, even though the third quarter is traditionally the quietest time of the year.
“Growth is coming without the benefit of a recovery in the structured finance market and despite a decline in European issuance,” said Harold McGraw, chairman and chief executive of McGraw-Hill, last month. At Moody’s, the picture is similar.
For potential newcomers, such as Meredith Whitney’s company which is seeking approval from regulators to become a rating agency, it is difficult to compete against such established agencies. Fitch Ratings, for example, has been in the business for many years, but has remained in third place after S&P and Moody’s throughout its existence.
One of the key ways to break into the business is to get the backing of investors, a strategy that other potential newcomers, such as a ratings firm set up by Jules Kroll, are pursuing. If investors say they will only buy bonds rated by a certain company, then debt issuers have a reason to include those ratings when they sell bonds.
Ralph Daloisio, managing director at Natixis, a bond investor, says there are investors willing to buy bonds without ratings, but this would be a “very narrow market”. “Ratings have woven their way into the fabric of financial society and I don’t know how you can extract that,” said Mr Daloisio.
In recent months, the many lawsuits that have been filed against the big rating agencies for their actions in the run-up to the financial crisis have also failed to dent their market share. Indeed, so far none of the legal procedures have resulted in the rating agencies being found liable for inaccurate ratings.
However, with many new rules still being written, and litigation still working its way through the system, it is unclear exactly what profit margins will be in the future.
“There are a lot of uncertainties in what the pipeline would be like and what any additional regulatory issues and compliance costs [will be],” said Mr McGraw.
The rating agencies, though, seem sanguine. S&P, for example, said last month its medium-term projection is for profit margins of more than 40 percent.