MISSION INTANGIBLE

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MISSION:INTANGIBLE, the blog of the Intangible Asset Finance Society, offers critical comments on intangible asset, corporate reputation, and finance; supplemented by quantitative reputation metrics. Intangible assets include business processes, patents, trademarks; reputations for ethics and integrity; quality, safety, sustainability, security, and resilience; and comprise 70% of the average company's value. MISSION:INTANGIBLE is a registered trademark of the Intangible Asset Finance Society.

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Moody's and S&P: Mission:Irrelevance

C. HUYGENS - Friday, December 21, 2012
The intangible asset of interest is quality, and the problem  -- according to Blackrock (BLK) -- is that it's missing. Bloomberg reported yesterday that "Credit rating companies are distorting capital markets by assigning the same debt ranking to countries from Italy to Thailand and Kazakhstan, according to BlackRock Inc. (BLK), the world’s biggest money manager...For BlackRock, which oversees $3.7 trillion in assets, the measures are so untrustworthy that the firm is setting up its own system to gauge the risk of investing in government bonds."

The ratings agencies generate a product that customers do not value, or even trust. As we shared before, the regulators are upset that the product is distorting markets. The book Reputation, Stock Price and You: why the market rewards some companies and punishes others, explains how one of the cardinal signs of a reputational value crisis is when stakeholders turn on you. Watch this one closely.

Moody's and S&P: Spinning yarn

C. HUYGENS - Tuesday, December 18, 2012
Chanel used to say, ‘If a woman walks into a room and people say, “Oh, what a marvellous dress,” then she is badly dressed. If they say, “What a beautiful woman,” then she is well- dressed.’ S&P & Moody's similarly, provide the service of adorning countries with ratings that, in the ideal, make them attractive to investors. Look at the country, not the rating, they would say. Unfortunately, the ratings agencies lately have been attracting far too much attention to themselves.

Japan’s Financial Services Agency last week said it ordered S&P’s Japan unit to improve its system for verifying and updating ratings. In November, an Australian judge ruled S&P misled investors by giving its highest ratings to securities whose value plunged during the global financial crisis. Yesterday, Bloomberg reports that this year's ratings calls missed market movement more often than they concurred. "Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of the 32 upgrades, downgrades and changes in credit outlook, according to data compiled by Bloomberg. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974. This year, investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by S&P." 

In 1909 John Moody had a good story. Access to information was slow and expensive, and the cost of ignorance was evident in the losses of the 1907 market crash. Today, the rating agencies' story is being blamed, in part for the losses of the 2008 market crash. One would expect reputational value consequences, and yet...

The Steel City Re Reputational Value Metrics show that Moody's ranking is at the median and trending up, while its return on equity is already the top percentile among 15 financial publishing peers. Current volatility of RVM, a non-financial measure of reputational value, is very low. The vital signs present an odd mix of data. Is Moody's making up for lost ground, or have investors gone whacky? Things are not in balance raising the question: Will the the story morph into the fable, "The emperor's new clothes?"


S&P: A league of its own

C. HUYGENS - Tuesday, October 09, 2012
Bloomberg has a thing for Standard & Poor's, the rating agency subsidiary of the McGraw Hill Company (MHP). Inspired by S&P's unilateral downgrade of US debt in August 2011, Bloomberg started asking questions and concluded that when it comes to sovereign debt, S&P is out of its league. (Moody's and Fitch still give the US their highest ratings.) Looking at the latest update yesterday (Detrixhe J, 8 Oct), the message from Bloomberg comes in three parts: S&P doesn't have the competency, their ratings upgrades/downgrades are no better than a coin toss, and if you will lose money if you believe them.

David Jacob, who was fired from S&P in December, said in a June interview that grading government bonds is outside ratings companies’ traditional areas of expertise because “you’re talking about politicians, you’re talking about legislators, you’re not talking about credit risk.”

Predicting the reaction to rating changes by S&P or Moody’s is little more than a toss up, with yields moving in the opposite direction than suggested 47 percent of the time, according to data compiled by Bloomberg in July. Yields were measured after a month relative to U.S. Treasury debt, the global benchmark.

Pacific Investment Management Co.’s Bill Gross,...who manages the $277.7 billion Total Return Fund, ... eliminated government-related debt from the Total Return Fund in February 2011 and said in March of that year that Treasuries needed to be “exorcised” from portfolios. The fund lost against 70 percent of its peers that year, prompting Gross to capitulate and buy U.S. government debt.


Bloomberg's comments comprise a Clausewitzian strike at S&P's reputation: a challenge to their product's quality. The First Amendment to the US Constitution grants S&P the freedom to opine on the credit ratings of any sovereign--a hollow right if no one cares to listen.

Meanwhile, over at S&P's competitor, Moody's things are looking up. The Reputational Value Metrics from Steel City Re show a stable reputation ranking (CRR) among its 15 peers in the Financial Services/Publishing sector. Reputation stability is the defining feature of Moody's (MCO) metrics with the resulting benefit that it is outperforming its peers and rewarding its equity investors.

Moody's: Did you say something?

C. HUYGENS - Wednesday, June 27, 2012
The rating agencies received an earful for mis-rating debt obligations collateralized by tranches of securitized mortgages. Investors alleged that Moody's (MCO) and others misled them. The rating agencies reminded the investors that ratings comprise first amendment-protected speech -- opinions, if you will -- and that no one is under any obligations to accept them as fact nor rely on them as oracular truths. The markets are taking the hint.

Bloomberg describes the problem this way (Campbell and Moore, 22 June): "Moody’s Investors Service suffered a downgrade of its own as markets responded to the company’s rating cuts of 15 of the world’s largest banks by bidding up the value of their stocks and bonds...'We view the Moody’s downgrade as another overhyped story of 2012,' David Trone, analyst at JMP Securities LLC, wrote to his clients. 'The corporate market thinks for itself and credit rating agencies are often lagging indicators.'"

Turning to the Steel City Re reputation metrics, Moody's reputation ranking has rarely been greater than the median over the trailing twelve months -- a point that is quite telling for what may be the best recognized brand in the business. With respect to vital signs, Moody's is currently ranked in the 60th percentile relative to its peers, its return on equity is at the 50th percentile, is reputational volatility creeping up from the 20th to the 27th percentile, and its stability is only at the 13th percentile. Oh yes, the change of direction indicators are all negative. Times are a changin'.

Moody's: Rotten in Denmark

C. HUYGENS - Wednesday, May 02, 2012
Providers of subjective metrics are have a hard time in the markets today. That's placing S&P, Fitch, and Moody's is a tricky situation. Say something unflattering, and you run the risk of being disregarded. Hence, this lede from Bloomberg last week (April 19, Schwartzkopf), "Denmark’s biggest banks are firing Moody’s Investors Service (NYSE:MCO) as they win assurances from some of the country’s biggest investors that the opinions of ratings companies hold limited value."

The latest bank to send Moody's packing is Nykredit A/S, Denmark’s biggest mortgage lender and Europe’s largest issuer of covered bonds backed by home loans. the bank terminated its contract with Moody’s on April 13, citing its “volatile” views. Bloomberg adds, “It’s not a matter of the rating being X or Y,”  Soeren Holm, group managing director of finance at Nykredit, said in a phone interview this week. “It’s a matter of volatility in their methods and approaches, and it’s a matter of the value for investors.”

There are 16 firms that publish financial information for which Steel City Re tabulates reputational metrics. Relative to its peers, Moody's has had a volatile year starting at the 25th percentile 12 months ago, bottoming out in August at zero, and closing most recently in the 53rd percentile. Its reputation is more volatile currently at the 20th percentile than it has been historically at the 13th, but its forecast stability is above the median at the 60th percentile. Its 12 month return on equity is in the 83rd percentlle. The current trends for all reputational metrics are positive, but it is hard to know if this is only because -- relative to peers -- things were rather ugly last year.

McGraw Hill: Rating the rater

C. HUYGENS - Friday, August 12, 2011
It’s been a heady week for Standard & Poor’s, the rating agency that is a division of McGraw Hills Companies (NYSE:MHP). All that publishing work -- known in the industry as practicing first amendment rights to opine on the credit rating of both sovereigns and companies -- has evoked a not insubstantial amount of press attention. This is not necessarily good. Former EF Hutton CEO Robert Rittereiser, an authority on financial turnarounds and reputational crises notes, "On Wall Street, the probability of an entity retaining its wealth is inversely proportionate to the amount of coverage it receives in the Wall Street Journal."

Turning the the sources of this week's press attention, in the event that you have just been let out of jail or have moved to the planet earth from elsewhere, scores of companies and entities saw their credit ratings hit Monday after S&P downgraded the United States. Interesting, reports AFP (Aug. 8), the ratings agency did not downgrade commercial banks, especially the four largest seen as resting on the implicit "too big to fail" policies of the government. As the impact of its cut of the US rating from triple-A to AA+ began to hit markets, S&P announced that numerous government-related enterprises like Fannie Mae and Freddie Mac were likewise downgraded because they depend on the government's guarantee of their own bonds. Seventy-three investment funds -- fixed-income funds, exchange-traded funds, hedge funds, and others -- were downgraded, 70 of them by two notches, because they each had "significant exposure" to U.S. government debt. Ten insurance companies were hit, five with downgrades to AA+, including TIAA, USAA, and Northwestern Mutual, for their huge holdings of Treasury securities. Five others, including Berkshire Hathaway, the investment vehicle of billionaire Warren Buffett, kept their AAA ratings but were given negative outlooks.

The value-sapping blow back began shortly thereafter as many critics began to express doubt over the value proposition underlying S&P's core business model. "Credit ratings are becoming irrelevant in a bond market where investors still perceive AAA companies from Johnson & Johnson to Microsoft Corp. to be a higher risk than recently downgraded U.S. Treasuries," reports Bloomberg (Aug. 11, Detrixhe, Faux). After the U.S. was downgraded to an AA+ rating by Standard and Poor's, the extra yield investors demand to own bonds issued by top-rated companies versus Treasuries reached 0.81 percentage point, the most since July 2010, according to Bank of America Merrill Lynch index data. The wider spread suggests that investors still believe the highly-rated companies are a bigger credit risk.

There's more. As we have often noted, the real effects of a reputational crisis become apparent when regulators take interest. As evidence that the full "pile on of regulators, litigators and mommy bloggers" has set on Standard & Poor's, the SEC reportedly has asked the credit rating agency to disclose who within its ranks knew of its decision to downgrade US debt before it was announced last week, as part of a preliminary look into potential insider trading, the Financial Times (Aug. 12, Scannell) reports. The inquiry was said to have been made by the SEC's examination staff, which has oversight of credit rating firms. The exam staff can make referrals to the SEC's enforcement division if it believes any laws have been violated, but the inquiry might not result in a referral. Proving someone leaked information about the downgrade, or traded ahead of it, could be challenging. Many traders anticipated the downgrade and bets could occur across numerous securities or currencies without inside information.

S&P's reputation was tarnished during the great crash of 2008 when it became apparent that many of the complex structured products it had rated as AAA were much riskier. That story, as you know, has not yet played out fully. The numbers suggest that S&P's reputation was making a comeback until recently. According to the Steel City Re Corporate Reputation Index, McGraw Hills Co's ranking twelve months ago ranked in the 25th percentile among a peer group of 12 companies in the publishing/services business. That ranking peaked at the 60th percentile, only to drop over the past few weeks to the 36th percentile.

The company's exponentially weighted moving average ranking volatility peaked at almost 200%; its downward curve was arrested this past week as both the velocity and vector affirmed negative trends of -18% and -3.9% respectively.

The company's current return on equity (ROE) over the trailing twelve months is 25%. That is unlikely to persist as the reputational volatility grows for the reasons discussed above. On the basis of reputational metrics alone, this is not a stock to own. Expect a takeover with managerial overhaul -- a strategy that many wish would be realized by News Corporation, too.

Moody’s: Lynn Turner calls for guns and badges

Nir Kossovsky - Monday, April 05, 2010
Can shareholders rely on corporate boards to protect their interests? By Delaware law, certainly. The Duty of Care holds Directors responsible for oversight, and personally liable in the absence of oversight when it should have been there. Ask Society IA Corporate Governance Committee Chair Cathy Reese, an authority on board civil liabilities.

But guns and badges? Apparently, according to Advisen Front Page News,  which quotes last week Lynn Turner, a former chief accountant of the Securities and Exchange Commission who's criticized the failure of ratings agencies to see the risks in the failed Houston energy giant Enron Corp., which collapsed in late 2001. "I personally think until law enforcement agencies start holding these boards accountable, the point you're raising is probably right on target, and you're probably not going to get a lot of change."

Since the quote was in the context of an article on Moody’s Corporation (NYSE:MCO) and allegations of inadequate board oversight and risk management, we look at Moody’s reputation as captured by the Steel City Re Corporate Reputation Index.



The graph shows volatility, for sure, but over the course of the year among its 23 peers in the Diversified Financial Services sector, Moody’s reputation index climbed slightly from the 65th percentile to the 72nd percentile. There was a brief depression in September when Moody’s provided a somber earnings guidance, but both its reputation and economic returns bounced back to their mean trend for the year by year’s end. Moody’s ROE finished only 0.25% below the median of its peers and approximately equal to the period’s return for the S&P500.

Where does that leave us with respect to the value of the intangible asset of effective corporate governance? While sympathetic to the concept that criminal risk may foster compliance better than civil risk, we are still of the opinion that there is value to be discovered simply through superior governance as it manifests in ethics, quality, innovation, safety, sustainability and security. A riff on that concept is the subject of our Mission Intangible Monthly Briefing this Friday, 9 April, featuring Society Committee Chairs Paul Liebman from Dell, Inc. and Jon Low from Predictiv.

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