Credit Rating Firms – They’re Back

Tuesday, December 15, 2009

1168100_victoryIn September there was talk of the credit rating agencies fading away. Credit ratings were going to be removed from investment guidelines, bond issuers would not bother getting their securities rated and Congress would adopt financial controls to diminish the raters’ independence.

Well, the credit raters are back, and they’re showing the kind of strength that will return them to their former position in the financial industry.

Here is what’s happened

On September 25 I wrote, “Credit Ratings Are Not Going Away,” explaining why I thought the negative conclusions about the raters were wrong. Recently, we have seen a number of developments showing their return to normal. The significant ones last week were the following:

On December 8 The New York Times had a cover page article, “Back to Business – Debt Raters Avoid Overhaul After Crisis” (page A-1). “Overhaul” means Congress’ new financial legislation, so the raters are no longer viewed as the problem.

On December 9 The Wall Street Journal had a cover page article, “Countries’ Debt Woes Pose Risk to Upturn” (page A-1). With debt concerns popping up in Greece, Italy, Dubai, the UK and elsewhere (even the US), everyone is turning to the raters to see what they think.

The raters’ improvement is mirrored by Moody’s stock price, up nicely from the mid-September doldrums, although still far below its 2006/2007 highs of around $ 70.

Moody's MCO

And here is what’s coming…

The raters are not about to give a pass to Wall Street’s creations for quite some time. Don’t expect them to be friendly to the new concoctions we read about (e.g., “contingent convertibles” or “coco” bonds) and the supposed return to past practices (e.g., “covenant light” and “payment-in-kind” bonds). Moody’s, Standard & Poor’s and Fitch are not about to repeat any lenient practices.

In fact, they will likely be hard on anything new and be quick to downgrade. The benefit to us by such an attitude is that investment industry growth from here will be built on sound, proven fundamentals. Also, as we are seeing, the raters are going to be tenacious watchdogs regarding the debt and deficits governments have taken on.

By the way, expect Morningstar’s credit rating service to meet weak acceptance. With the main three regaining their positions, investors will take a wait-and-see attitude, so issuers will take a pass on using Morningstar as an additional or replacement credit rater.

* * *

So, the credit raters are back, and that is good. For investors, still avoid bonds (for the reasons that I have previously discussed), and, especially, avoid lower quality securities. They may have risen sharply from their sell-off bottoms, but any hiccup will have the raters crying, “Watch out!”

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