Credit raters reap rewards of non-reform

February 1, 2011

By Richard Beales and Agnes T. Crane
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Rating agencies were just branded “essential cogs in the wheel of financial destruction.” Despite the label from the U.S. commission studying causes of the crisis, rating firms are on the mend. Resurgent markets help. But policymakers, especially the gnomes of Basel, have failed to dilute their influence.

Standard & Poor’s, as parent McGraw-Hill now defines the unit, pulled in $1.7 billion in revenue in 2010, 10 percent more than the year before, as companies flocking to raise debt fueled demand for its ratings. Moody’s Investors Service, meanwhile, expects to post a 13 percent jump in revenue.

Considering the widespread crisis blame flung at raters, they’re making quite a comeback. True, Moody’s shares at around $30 apiece are still 60 percent below their 2007 high. Then again, the securitization machine that juiced profit during the boom is still flatlining. Even without that, both S&P and Moody’s are running with roughly 40 percent operating margins — not quite the 50 percent-plus Moody’s boasted in 2006 and 2007, but healthy nonetheless.

That suggests much-touted recent reforms haven’t challenged their keystone status in global credit markets, and perhaps never will. One central problem is that bank watchdogs need to measure credit risk to set capital requirements. Ratings from S&P, Moody’s and to some extent Fitch Ratings have always been a convenient yardstick. Regulators are struggling to find alternative methods beyond relying on banks’ own metrics.

The latest global bank capital standardization effort, known as Basel III, continues to embrace ratings. U.S. lawmakers tried to go the other way in last year’s Dodd-Frank Act, requiring the eventual excision of references to ratings from certain statutes and regulations — a possible wrinkle when it comes to implementing Basel III in the United States. But they undid some of the good work by insisting on regulating rating firms more heavily, thereby bolstering the perception that ratings come with official approval.

The result is that the basic industry model — oligopolistic, officially recognized ratings that are still mostly paid for by the borrowers being rated — remains intact, if encumbered by more red tape than before. For now at least, that’s similar to the more or less business-as-usual result achieved by the banking sector.

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