Don't upset them or you won't get straight As

Why the ratings agencies have the power to make corporate giants quail
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The Independent Online

The story is told of an analyst from one of the big credit rating agencies pitching up at the Zurich headquarters of a large Swiss bank, there to gauge its credit-worthiness or otherwise. Having been treated with the disdain for which these gnomes are renowned, the analyst returned to London harbouring a deep vendetta, downgraded the value of the bank's debt and sent its shares into free fall. On his next visit, needless to say, the bank laid out the red carpet.

The story is told of an analyst from one of the big credit rating agencies pitching up at the Zurich headquarters of a large Swiss bank, there to gauge its credit-worthiness or otherwise. Having been treated with the disdain for which these gnomes are renowned, the analyst returned to London harbouring a deep vendetta, downgraded the value of the bank's debt and sent its shares into free fall. On his next visit, needless to say, the bank laid out the red carpet.

Like any old wives' tales, this story may be apocryphal, but its moral is worth heeding. Just ask BT, which last week was forced to delay the sale of $10bn of bonds just because Standard & Poor's - along with Moody's the world's most influential arbiters of a company's ability to repay its debt - was threatening a downgrade. As it transpired, S&P did not drop the bombshell of branding Britain's telecoms carrier with a "BBB" label, the fixed-income market's equivalent of suspension from school. But the mere threat of that sanction was enough to derail the funding plans of one of Europe's largest companies.

The fact is that S&P and Moody's - and to a lesser extent Fitch IBCA, the market's bronze medalist - have the power to upset the best-laid plans of even the world's largest companies. When a business needs to borrow money, these small agencies wield far more influence than the might of all the world's investment banks combined.

The head of credit research at one investment bank, whose time is presumably precious, says: "We talk to them constantly. We are always trying to figure out what they're thinking."

There is something rather quaint about the notion that this banker, no doubt in the £1m-a-year pay bracket, is beholden to the views of an analyst earning a tiny fraction of that. And the origins of both S&P and Moody's, which can be traced to the start of the last century, are indeed humble.

The latter still bears the surname of its founder, John, who in 1900 began publishing Moody's Manual of Industrial and Miscellaneous Securities for the enlightenment of uninformed investors. By 1909, he had adopted a symbolic representation of credit risk which was soon widely used by American bond investors. His devotees were rewarded during the Great Depression of the 1930s when most of Mr Moody's recommended firms managed to avoid bankruptcy, then the fate of so many US businesses.

S&P, meanwhile, was formed in 1941 by the merger of the Standard Statistics Bureau - set up in 1906 to provide otherwise unavailable data on US companies - and Poor's Publishing, named after Henry Varnum Poor, author of the 19th century's definitive guide to railroad operators' finances.

Both Moody's and S&P have since been subsumed by larger companies, the former by Dun & Bradstreet, the latter by McGraw Hill. But their influence is undiminished. Even in the 21st century, many investors refuse to touch a bond unless both agencies have blessed it with at least an "A" rating.

Eric de Bodard, managing director of European corporate finance at Moody's, says: "We're in the business of opinions, and ratings are an individual opinion of a company's ability to face its debt."

Of course, the reputation of these ratings rests on the reputation of the opinion-formers. "We try to get people with knowledge of specific sectors and accounting issues," adds Mr de Bodard. "People who have been around and know their industry very well."

Indeed, the average Moody's analyst is in his early 40s, he says, a good deal older than the usual City analyst. But such experience does not prevent regular accusations that either Moody's or S&P has got it wrong.

"They're wrong a lot of the time," says a senior credit analyst with an investment bank. "They are often an impediment to the system."

One of the criticisms of the agencies is that their more bureaucratic modus operandi can render their ratings "yesterday's news". There is also a belief, voiced in some quarters, that their verdict is often at the personal whim of the analyst. The agencies reply that, in fact, decisions are only reached after cases have been studied by at least five analysts.

"Our value is in our brand name which we have built up over a century," says Chris Legge, S&P's director of corporate ratings. "Neither senior management nor our analytical staff will jeopardise that brand name."

Nevertheless, BT would not be the first to complain about unfair treatment at the hands of rating agencies. Bernie Ecclestone, the motor racing entrepreneur, found them less than amenable in 1998 when he was attempting to sell his $2bn Formula One bond. In 1996, Clerical Medical threatened to withdraw from S&P's service after an unfavourable judgment.

But the case of Orange County shows how difficult it is for these agencies to please. In 1994, when the Californian district went bust after running up enormous losses in the derivatives market, it sued S&P, not - as you might think - on the grounds that the agency had undervalued the quality of its debt. In fact, Orange County claimed that the "AAA" rating it had been assigned had given it a misleading impression of its financial strength.

It shows you can never win.

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