In a new report, Janney Capital Markets analyst Tom Kozlik calls out Standard & Poor’s for credit ratings on local governments that he says are too liberal. Kozlik claims that S&P is inflating ratings. I think his analysis is solid, but inconclusive given the size of his claim. Kozlik opens the door to more critical analysis of the comparability of ratings.
The Bond Buyer wrote:
Since S&P updated its criteria, it is more common for issuers to have ratings from S&P that are multiple notches higher than their ratings from Moody’s. ‘This leads us to believe that ratings shopping will continue, perhaps at an even faster pace than before,’ Kozlik wrote.
Ratings are opinions. There is nothing in federal law or the SEC rules that says one rater must be as conservative as another. Credit rating firms are free to analyze bond issuers however they want, as long as they disclose the methodology. Kozlik seems to believe, like most of the market, that raters should assign alphanumeric ratings in a standardized way to signal risk on an equal scale.
Issuers obviously want the highest rating possible so they can borrow money at the lowest cost. Investors want the opposite — for issuers to get critical ratings so they can get paid higher interest rates. Issuers often “shop” their ratings to find the best one.
There are ten raters that are officially “recognized” by the SEC to assign ratings. Four of these firms assign ratings for muniland (Fitch, Kroll, Moody’s and S&P).