It is very unclear what will be the final role and business strategy of the agencies. They have lost credibility, many of the smartest and most experienced have left or will leave as soon as they find a new job, they will soon be subject to the fear of the tort lawyers coming after them for any reason that can force a payoff to the lawyers, and they have competition. If there were not the requirement to use investment grade ratings from rating agencies imposed on pension funds and certain other investors, it is very likely that the rating agencies would simply go away.
There is now an internal layer of monitors in the agencies checking to make sure the underwriters are doing it by the book and not going out on a limb on anything. This makes working conditions less than wonderful and it results in generally more conservative ratings than might otherwise be the case and might otherwise be warranted. Similar to appraisers who always get it wrong on the upside and then over compensate and get it wrong on the downside when there is a recession, raters are now being conservative. If you know a tort lawyer is sitting there waiting for you to make any judgment that may prove later to be over optimistic, you will err to the conservative side. If you know Barney Frank and his band of clowns on his committee will potentially drag you in front of the cameras for political theater, you will be overly conservative. Being overly negative can be as bad as being overly optimistic if the rating is too restrictive and the cost of capital resulting is higher than it should be.
Blackrock and Pimco and others are now taking market share from the agencies as they are considered to be better analysts of the securities for investors such as insurance companies and others. I expect this trend will continue just as it did years ago with equity research when there was a major move away from the big wire houses research groups who were found to have another axe to grind- mainly push the companies who were clients and IPO issuers of the firm. The rating agencies never, to my knowledge, did anything like the dishonest work of the investment banking research groups, but the trend to use better quality research firms will be the same because the results of the past were unsatisfactory and often inaccurate.
It is not clear where all of this will end, but it is clear the role of the agencies will never be the same and will diminish. We got in trouble partly because investors blindly bought issues solely on the rating, and never did any work at all to test the quality of the ratings work. Ratings became like a word from God or the Pope, and few questioned the validity. The smart investors now realize there are options and better choices, and they are starting to take them. Investors may actually have to work at investing now, and look at what they are buying, instead of just buying on the basis of a few alphanumeric indicators issued by a group of analysts nobody ever met, running models most people have no assessment of, and which have proven inaccurate by large margins. The talent at the agencies able to assess complex structured deals is walking out the door. The impact on future CMBS issuance will be noticeable and likely will inhibit volume and investor acceptance in the future. It will likely take another year or so before we know the future of ratings and the agencies role.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
