November 21, 2014
Does Morningstar Speak with Forked Tongue?
Morningstar Credit Ratings, a small Nationally Recognized Statistical Rating Organization (albeit a subsidiary of Morningstar, the large investment research firm), has issued a Structured Credit Ratings Commentary on Rating Shopping in Asset Securitization Markets. It finds that
Rating shopping is alive and well in the U.S. securitization markets notwithstanding the implementation of regulatory and legislative actions intended to curb the practice and promote competition among credit rating agencies, or CRAs. It is important to note, however, that the rating shopping following the financial crisis has not led to a “race to the bottom” scenario with respect to rating standards that some congressional lawmakers and other critics of the issuer-paid model believe was prevalent during the years leading up to the crisis. (1)
I have to say that I find Morningstar’s analysis perplexing. The commentary highlights a number of structural problems in the ratings agency industry. It then goes on to say that everything is fine and that there is no race to the bottom to worry about, to lead us into another financial crisis.
The commentary goes on to state that while
it is rational for issuers and arrangers to choose the CRA with the least onerous terms, CRAs generally have held their ground by adhering to their analytical methodologies notwithstanding the constant threat of losing business. . . . The CRAs’ unwillingness to lower their standards in the midst of reviewing a transaction is attributable in part to strong regulatory oversight from the SEC, which has focused heavily on holding nationally recognized statistical rating organizations, or NRSROs, accountable for following their published methodologies. (1-2)
I find it odd that the commentary does not consider where we are in the business cycle as part of the explanation. Once the market becomes sufficiently frothy, rating agencies will be more tempted to compromise their standards in order to win market share. I wouldn’t accuse Morningstar of speaking with a forked tongue, but its explanation of the current state of affairs seems self-serving: move on folks, we rating agencies have everything under control for we have tamed the profit motive once and for all!
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