Sell Side

Kroll on Fast Track To Ratings

Kroll Bond Ratings is moving more quickly than originally anticipated to rate municipal bonds because of a growing relationship with startup bond insurer BondFactor Co., a company executive said Friday.

Kroll  acquired its designation as a nationally recognized statistical rating organization in August when it acquired LACE Financial. It plans to begin rating structured finance products in the next few weeks, followed by public finance issuers later this year and corporate issuers in 2012.

The agency was founded by Jules Kroll, who in 1972 established Kroll Associates Inc., an investigative and corporate security firm. He ran the company for 34 years and sold it to Marsh & McLennan in 2004.

This newest entity has not issued a rating yet, but it is working with issuers now and has two signed engagement letters, according to James Nadler, president and chief operating officer.

“You’ll begin to see our criteria and research coming out in the next three to four weeks,” Nadler said.

Brad Wendt, president of BondFactor — which also seeks to enter the market this year — confirmed that the new insurer has been in talks with Kroll, as well as with Standard & Poor’s and Moody’s Investors Service, to seek a rating. Fitch Ratings is no longer analyzing bond guarantors.

BondFactor seeks to insure municipal bonds using a pooling method described by some as “a muni-collateralized debt obligation.” The structure comes naturally to Kroll, Nadler said, because it requires analysis from people with knowledge of structured finance as well as public finance.

“Kroll does a good job on interdisciplinary things, where you take a view from different areas,” Nadler said. “You may take some information from the structured side or the corporate side, and because we are small and nimble, it’s easy to put in an interdisciplinary group.”

Nadler said the agency has not yet been in discussion with other bond insurers such as Assured Guaranty Ltd. or MBIA Inc.

The public finance market offers the biggest opportunity for the new agency after structured finance products, Nadler said.

In both instances, the company believes it can add value by developing a deep relationship with investors and adding “meaningful commentary” to the marketplace.

“We want to change the paradigm,” Nadler said. “We want the rating agency to do what it was originally intended to do — and that is to be a voice for investors.”

The rating agencies forgot that purpose and devolved into “a monolithic business that pays no attention to its ultimate constituents,” he added.

The agencies have been criticized for assigning ratings that proved to be too optimistic as the meltdown in the market for mortgage-backed securities helped spark a worldwide financial crisis.

Nadler knows the rating agency world from experience. He began his career as a ratings officer with Standard & Poor’s, and from 1989 to 2001 he worked at Fitch, where he was an executive vice president and led the structured finance group.

Nadler then co-founded Criterion Research Group, an independent firm that was sold in 2006.

He spent the last four years on the buy side at General Re Corp., the reinsurer owned by Berkshire Hathaway, before moving to Kroll in August.

“I have a fresh and real understanding of what investors want and what they need,” Nadler said. “Most investors don’t have a staff of 100 people to look at all these bond issuances. They need information from various sources and the rating agencies are one of the main places they can get information.”

The subprime mortgage crisis, however, revealed some fundamental problems at the rating agencies and created an opening for some new competition.

Jerome Fons, executive vice president at Kroll, wrote in late 2010 that the crash of 2008 “poured discredit on to rating agencies that has yet to be dispelled.”

Fons, formerly a managing director of credit policy at Moody’s where he worked from 1990 to 2007, criticized the rating agencies for lacking transparency, due diligence, and good governance.

At a conference held in November by the National Association of Insurance Commissioners, investors and analysts agreed that the rating agencies had done an admirable job in rating municipal bonds over the past four decades.

“If anything, historical municipal bond ratings have been more conservative than the actual rates of default in the public finance market,” Richard Larkin of Herbert J. Sims said at the conference, “

Early last year, Fitch and Moody’s recalibrated their public finance ratings onto the global scale, which resulted in higher ratings for muni bonds across the spectrum. Standard & Poor’s maintains their ratings have always been on a global scale, but analysts have noted their public finance ratings also crept upwards over the past few years.

Nadler wouldn’t say if public finance ratings are, on the whole, too low or too high.

Nor is that necessarily the issue. The rating will often be correct, he said, but the commentary won’t be detailed or timely enough to really help investors. That’s where Kroll sees an opportunity.

“We can’t go out and tell investors, 'We think rating agencies are way too high on everything, and here’s the way we’re going to look at’ — you’re not going to see that from us,” Nadler said. “What you’re going to see is areas where we can do better due diligence, give them more information, and be more transparent.”

Another key is providing better post-issuance surveillance, an area that Fons said was “noticeably missing” before the financial crisis. That surveillance creates a feedback loop to incorporate new research and rating methods.

LACE, the company Kroll acquired in August and renamed in December, currently rates 20,000 financial institutions, including “virtually every” commercial bank and credit union in the country, Nadler said.

While Kroll will operate with an issuer-pays model for structured finance products, public finance bonds, and corporate debt, the operations inherited from LACE operate independently, offering quarterly updates to paying subscribers.

Partly owing to that relationship, Nadler said Kroll has the resources to develop a better relationship with investors than competing rating agencies.

“There’s an opportunity there for more and better due diligence,” Nadler said. “That’s really in our DNA.”


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