I don’t buy the claim by Sean Egan, he of the the-bond-guarantors-will-need-to-raise-$200-billion claptrap, that his rating agency’s business model enables him to turn out inherently more trustworthy ratings than Big Threes’ because, since Egan-Jones gets paid by investors not issuers, its interests are in parallel with the people who actually rely on his ratings. That’s nonsense.
If anything, Egan-Jones has a conflict of interest that’s more severe (and perhaps much more) than anything Fitch, Moody’s (MCO), and S&P (MHP) to deal with. To begin with, companies that issue public debt have to have it rated. They have no choice in the matter—which means that they have essentially zero sway with the agencies if they want to get a deal done.
Egan Jones, meanwhile, depends on its paying clients—institutional investors such as hedge funds—to keep its doors open. And, as he recently told Kate Welling, “There is all the difference in the world between investor-supported and an issuer-supported rating firm.”
Yes there is. But not in the way that Egan seems to so sanctimoniously believe. I haven’t see Egan-Jones give a breakdown of its revenues by client, but it is theoretically possible (even likely) that the firm’s top 10 clients generate over 80% of its revenues. It is highly conceivable Egan-Jones might feel some pressure to turn out research that carries investment conclusions that would support its biggest clients’ largest positions.
Could it be, for example, that the Egan-Jones’ largest revenue-generating clients are hedge funds that are short the debt or equity of the financial generators? Why, yes, it could be! Is it also possible that Egan-Jones’ might use its reports and debt ratings to curry favor with those clients by expressing excessively negative views about the prospects for the guarantors? Of course it is!
This sort of thing is hardly unknown on the sell side. A handful of equity research shops seem to consistently write negative reports, not necessarily because they are objective, but rather (I believe) because some clients will pay them to generate negative views for a variety of reasons.
I am not saying that Egan-Jones’ ratings are driven by its largest clients. I simply don’t know. But I find it incredible that Sean Egan is so emphatic about how lily-white his investor-supported ratings model is compared to the issuer-supported model. No, Sean, it’s not!
What is more important to me is the quality of the research, and the rationale supporting a rating--be it from Egan-Jones, or Moody’s, or S&P. And from what I’ve seen of Sean Egan’s work, on that score Egan Jones does not measure up.
Tom Brown is head of BankStocks.com.