Credit rating agencies are struggling to adapt to the coronavirus pandemic, reducing assessments of vulnerable businesses under the scrutiny of critics who blame them for exacerbating the latest financial crisis.
The agencies – led by the big three from S&P Global, Moody’s and Fitch – imposed major rating downgrades as the Covid-19 epidemic accelerated. March had the fastest decommissioning rate, with records going back to at least 2002, according to a report by Bank of America last week. The bank added that more issuers could expect their ratings to be anchored in the coming weeks.
Critics say it is a resumption of the 2008 financial crisis, when ratings that were too high dropped, amplifying a sense of alarm, particularly in the securitized markets filled with debt-backed bonds mortgage.
“We are there, already seen again,” said Dennis Kelleher, head of Better Markets, a consumer advocacy group. Notes are reduced “after what appears to be.” . . significant rating inflation, just like the last time, ”he said.
Agencies say they are simply reacting to changing circumstances, reflecting sudden tensions that have arisen in the aftermath of the coronavirus epidemic. “We are really trying to call it as we see it, by being balanced, but also recognizing that this is a very big stress facing the economy,” said Craig Parmelee, global practice manager at S&P.
About 80% of S&P rating stocks since early February – about 213 downgrades out of 4,000 rated non-financial companies – have concerned issuers already in “unwanted” territory before the coronavirus crisis, the company said.
“We are taking a thoughtful approach to downgrades across geographic areas and asset classes,” said Anne Van Praagh, head of credit strategy and research at Moody. “Our job is not to drop all the notes; it is of no use to anyone. Our job is to identify outliers. “
Fears that the ratings were set too high before the coronavirus outbreak came from agency business models, which are paid for by companies and governments whose credit ratings they assess. Rating a leading agency can facilitate the sale of a bond or loan, offering investors a theoretically independent view of the borrower’s prospects. These views are also closely linked to the mandates under which many fund managers operate, forcing them to sell bonds if the ratings fall below certain thresholds.
But issuers generally pay to be rated – a structure that can cause conflict, leading to accusations that agencies compete to win business by offering high ratings.
In 2015, S&P agreed to pay in the United States and declares approximately $ 1.4 billion to settle allegations that it raised notes on mortgage-backed securities in anticipation of the crisis, admitting that she had suspended her demotions for fear of losing market share. Moody’s paid $ 864 million in 2017 to cover similar charges.
Today, the pair accounts for 81% of current credit ratings, according to a January 2020 report from the Securities and Exchange Commission. Fitch still represents 13.5% of the market.
Before the epidemic escalated, regulators had questioned the agencies’ business practices. SEC chairman Jay Clayton said in November that agency activities should be monitored “on an ongoing basis”, while asking if there were “alternative payment models” that would better align agency interests rating with investors.
Egan-Jones, a smaller rating agency that is paid by investors rather than issuers, said in a letter to the SEC in January that “no amount of internal disclosure or separation of ratings and marketing personnel ‘is enough to overcome the defilement created by such conflicts’.
In their response letters to the SEC, Moody’s and S&P stated that potential conflicts are inherent in all of the rating agencies’ business models.
Analysts note that the “pay-as-you-go” model also results in some downgrade recipients behaving as if they were aggrieved clients of agencies, rather than impartial appraisers. Last month, SoftBank, the Japanese indebted group, complained of a downgrade in Moody’s credit rating, stating that the agency had made “excessively pessimistic” assumptions about the market environment.
Investors often make decisions independently of ratings from rating agencies. Cruise ship Carnival paid heavily for a new bond issue this week despite its investment grade ratings, as fund managers said the company was in jeopardy after the viral epidemic.
The debate over the rating agency business models is unlikely to fade, as this time the magnitude of the cuts is much broader than that of structured products. Already, downgrades from large companies such as automaker Ford and retailer Marks and Spencer, from the lowest of investment grade ratings to junk, have appeared to cause declines in credit markets.
The old flaws in business models are becoming apparent again, said Riddha Basu, assistant professor at George Washington University.
“It’s still the same after 10 years,” he said. “Nothing has changed much. “