|
|
IN TIMES OF financial plenty credit ratings go largely unnoticed. In downturns, though, they attract more scrutiny—and are often found wanting. The dotcom crash of 2000-01 exposed ratings of some erstwhile corporate stars, including Enron, as nonsense. Worse was to come in the financial crisis of 2007-09, which the three big rating agencies—Moody’s, S&P and Fitch—helped cause by trading reputation for profit and giving implausibly high marks to securitised mortgages. An official report on the crisis branded the agencies “essential cogs in the wheel of financial destruction”.
It is, then, no surprise that the ratings oligopoly faces another potential backlash, now that an even bigger pile of debt threatens to go sour, thanks to covid-19. Eyebrows have been raised as the agencies have rushed to mark down bonds and loans of all types. The pace of downgrading in March was the fastest recorded. As of May 5th, S&P had downgraded or put on negative watch a fifth of the corporate and sovereign issuers that it rates, in response to the virus and a tumbling oil price—and over three-fifths in the worst-hit industries, such as cars and entertainment. This burst of activity is stoking a familiar suspicion: that the rating firms let their standards slip in the go-go years, only to scramble belatedly to make amends once markets turned.
The accuracy of ratings matters, because the licensed firms that issue them wield great power over capital markets. A downgrade can cause a company’s funding costs to rocket, or a run on a bank. It can also force a corporate or sovereign borrower out of an index, draining the pool of investors willing or permitted to lend to it.
Far from having their wings clipped after messing up prior to 2007, the rating agencies cashed in on the past decade’s debt bonanza (see chart 1). At the end of 2019 global corporate-bond debt was $13.5trn, double the level of 2008 in real terms. With central banks using ratings to sift potential fodder for their asset-buying programmes, these grades have become even more crucial determinants of who can hold what.
The agencies argue that their ratings hold up well when viewed “through the cycle”, rather than over short periods of time. They also point to changes, imposed on them after the financial crisis, that have strengthened the walls between their analysts and sales teams. Ratings are paid for by the issuer; in the run-up to the financial crisis it was largely the fear that big clients, often banks, would take their business elsewhere that led the agencies to award overly generous marks to toxic loan pools.
It is also true that much of the lower-quality debt raised in recent years has received poor marks from the start. At the end of 2019 almost two-thirds of American leveraged loans rated by S&P were single-B (the mid-band of high-yield, or “junk”) or lower; at the end of 2007 just over a third were. The rating firms point to a plethora of reports they issued as debt built up, warning that things could get messy when sentiment soured. And for years they have highlighted the evisceration of “covenants”, or legal protections for creditors in the event that a borrower’s finances spin out of control.