🏦 What is the future of Credit Rating Providers in a world of Private Credit? - Asymmetrix Newsletter #74
How will Moody's, S&P and Fitch react to the growth of upstart providers?
After a mammoth analysis last week of June’s activity in the Data & Analytics market, this week we delve into one sub-sector in detail.
As Private Credit grows ever larger, what is happening in the world of Credit Rating? How are the traditional Credit Rating Providers - Moody's, S&P and Fitch - reacting, and what might happen next?
Thanks for reading!
Not a subscriber yet?
Please do consider sharing this newsletter with friends or colleagues who you think may be interested. Thank you!
🏦 Rating Private Credit
Last week, Asymmetrix discussed with some friends of the newsletter (YKWYA!) what the future holds in store for Credit Rating Providers in a world of private credit.
It’s an interesting avenue to explore, so we thought we’d share our thoughts with all our readers here.
Right off the bat, if you want to explore the world of Alternative Asset Management in more detail, Asymmetrix highly recommends Michael Sidgemore’s Alt Goes Mainstream Substack.
Every week Michael illustrates the seismic shift taking place in financial services as more companies stay private and use non-traditional funding sources to finance their operations.
For example, in his most recent article he reminded us of this gem from Apollo’s 2024 Investor Day illustrating just how large alternative asset managers have become over the past ten years.
Apollo views the private credit market as a $40tn addressable market:
With all of this non-standard debt floating around, how do investors know what is creditworthy and what is not?
Private businesses have a reduced burden of financial disclosure compared to their public counterparts, leading to a lack of transparency for investors.
In BlackRock’s acquisition of Preqin a year ago, BlackRock CEO Larry Fink clearly laid out the opportunity to provide data helping investors in private markets to properly analyse potential investments, trades and portfolios:
This acquisition is about driving evolution and growth in the private markets. by measuring them, understanding their drives of performance and making them more investible.
Think about how data, benchmarks and risk analytics transformed public markets… They made investment performance and drivers of returns much more transparent.
Our aim is to do all of that in the far less mature Data & Analytics and Index business for all the Private Markets.
As the private markets become mainstream it is unthinkable that investors will not demand greater transparency in order to lower risk and improve decision-making.
Transparency in financial services is often driven by regulation, which usually lags innovation, and sometimes requires a negative financial event to happen in order for regulation to be imposed.
In the case of private markets, this might look like a large default by an alternative asset manager with investments from pension funds holding the savings of the man in the street.
But those funds will not want to find themselves in this position, and will push to have the best possible information about their investments to avoid this happening.
And smart investors like Apollo, Blackstone and Carlyle (and the hedge funds keen to get a piece of the action) will want to have the best information in order to maximise their return on investment and avoid risk.
The Big Three rating agencies such as S&P, Moody’s and Fitch, who have over 90% market share between them, have a focus on global investment-grade bonds. But they are weaker in sub-sectors such as insurance and specialty finance, and they do not provide complete coverage of all debt instruments - only of those for which the issuers have been willing to pay.
In these areas, the other seven Nationally Recognized Statistical Rating Organizations (NRSROs) such as Morningstar DBRS, Kroll and DBRS have been taking market share.
Bloomberg also recently highlighted the growth of 20-analyst-strong Egan-Jones, who advertise their Private Placement Ratings service on their website offering “ratings of private placement securities for clients such as banks, asset managers, and other financial institutions seeking to raise capital in the private credit markets.”
Unlike the majority of their competitors, who get paid by the issuers, Egan-Jones typically gets paid by the people who buy the investments.
Whatever the business model, from an investor’s perspective, the key value of this information is derived from its accuracy, which can only be assessed after the fact.
The established players were widely criticised in the wake of the Global Financial Crisis, and tightened their methodologies. This partly explain their reluctance to expand into “riskier” assets.
But it seems likely that, unless they are willing to give up market share, they will have to diversify into the world of private credit.
How might they do this?
Partnerships
In April this year, MSCI and Moody’s announced a JV to provide independent risk assessments for private credit investments, combining “Moody’s EDF-X credit risk modeling solutions with MSCI’s universe of private credit investment data.”
However, Moody’s were keen to emphasise that “the solution will be distinct from the services provided by Moody’s Ratings, the credit rating agency, to the issuers in the private credit market.” They are clearly wary of any blowback from “inaccurate” ratings.
Expect to see more partnerships like this as the larger players experiment with broadening their coverage in a relatively safe way.
Acquisitions
It’s been a while since we saw consolidation in the world of NRSROs. Morningstar’s acquisition of DBRS for $669m in 2019 combined DBRS with Morningstar Credit Ratings’ US business.
Perhaps its time for one of the big players to dip their toe in the water. Financial services focused AM Best would be an obvious target for the likes of S&P or Fitch.
More probable is that a PE firm acquires one of the smaller players and uses it as a platform to combine several of them in a bid to take on the incumbents. This also seems less likely to encounter the anti-trust issues that would probably be incurred by a member of the Big Three.
PE interest is there: DBRS was previously backed by Carlyle and Warburg Pincus, and Parthenon acquired 90% of Kroll for $810m in 2021. Could the latter be the platform play?
In addition, Asymmetrix can’t help but feel that there is still room for innovation in this sector.
Although the moat of historic data makes it difficult for new entrants, this does not mean that it’s impossible. A truly independent and comprehensive credit ratings provider covering the whole market with accurate intelligence (perhaps using AltData and Artificial Intelligence) would be an incredibly valuable business.
It seems improbable that this opportunity is not already being explored by Data & Analytics entrepreneurs and investors. We will watch this space with interest.
📜 Interesting Content
Is the Age of Portal Empire Building Over? - Online Marketplaces
📧 If you would like to talk, please email us at a.boden@asymmetrixintelligence.com