Dodd-Frank rule 939A notwithstanding, credit rating agencies are here to stay.
Of all things that fit the saying “can’t live with them, can’t live without them,” credit rating agencies could be at the top of the heap. Even though they were one of the main culprits of the financial crisis with their careless ratings of mortgage securities, rating agencies have continued to remain vital to the business world and its regulators. So much so that even Dodd-Frank probably won’t kill them.
A recent article in The Wall Street Journal illustrates this point. Banks are required to hold certain amount of capital on their books to comply with rules under Dodd-Frank and Basel III. But under Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act regulators will be banned from using credit ratings of nationally recognized statistical rating organizations like Moody’s, S&P and Fitch, they may not be able to accurately assess the risk contained in those assets. And, according to the WSJ, banks say assessing this risk on their own isn’t viable. One of their big worries is that the ban “could create an unfair advantage for foreign banks whose regulators continue to use ratings.” So far even some regulators, like the Comptroller of the Currency, John Walsh, have testified before the Senate Banking Committee that the ban on using ratings in assessments “goes further than is reasonably necessary.” By the way, the Comptroller, along with the FDIC and the FRB, are the ones executing this part of Dodd-Frank.
At the May meeting of The NeuGroup’s Bank Treasurers’ Peer Group (BTPG), bank treasurers discussed what alternatives there were for credit ratings. Their main conclusion? There weren’t any. “Although rating agencies were at the heart of the cause of the crisis, there is really no living without them,” according to the meeting’s post-mortem. One banker in attendance noted that, “there is no answer for the ratings industry business model. The structure, the breadth and depth of S&P and Moody’s is so deep that it would take a lot of money to replicate it.” (See related story here)
And Wall Street itself gets this. Despite all the fuss about their role in the crisis, business for these companies is booming (although some corporates are trimming ratings relationships to just one vs. two and sometimes three — adding Fitch — a few years ago). Moody’s and S&P parent company McGraw Hill reported profit of 35 and 13 percent respectively in the last quarter.
As the proposed rule stands, regulators have until July 2011 to report to Congress on the progress they are making in removing “any reference to, or requirements of reliance on, credit ratings” from their books. In the meantime, banks will continue to seek those alternatives and rating agencies sector stocks will probably continue to move higher.