Credit ratings firms have been around for over a hundred years, and through those years the capital markets have created norms and rules that protect the ratings firms’ market and relevancy. These firms hold tremendous influence: a good or poor credit rating assigned to a company, industry, or government can have a profound impact on borrowing costs and decide if the rated entity enjoys access to the capital markets.
Call up any of these firms’ websites and you inevitably come across the much-vaunted values of the firm and the culture they warrant to embrace.
Perusing Moody’s website yields a bounty of virtuous tag lines: clear, credible, accurate, consistent, superior, quality, integrity, and fairly all play prominent in the firm’s website, policies, and communications. Other ratings firms mimic similar themes. These firms indicate to both the issuers and purchasers of debt that an objective rating will be provided, using quantitative metrics and clinical analysis.
The stark reality is quite different.
Credit rating agencies are notorious for picking subjective winners and losers across industries and entities by granting significantly higher or lower credit ratings than what quantifiable metrics should allow. Certain industries singled out as not worthy by these agencies unduly suffer costly, limited access to capital markets while too often fiscally inept governments can do no wrong in the eyes of the ratings firms. This creates hugely different credit ratings and borrowing costs.
A disciplined and stable corporation unlucky enough to be discriminated against by the ratings agencies can hardly access debt markets, and can only do so at elevated cost, due to the taint sprayed on it by the arbitrary credit rating. Meanwhile dysfunctional states and local governments on the verge of insolvency receive ratings as if they are Berkshire Hathaway.
The blatant bias of credit rating agencies in favoring broke states was underscored in 2010 when ratings firms, including Moody’s, decided to “recalibrate” their credit ratings for state and local government municipal bonds. Recalibration was code for a massive upgrade in ratings to tens of thousands of municipal bond issuers spread across state and local governments.
California and Puerto Rico (yes, the now insolvent Puerto Rico) were two of the biggest beneficiaries of the recalibration gift, receiving not just a single notch, but a three-notch upgrade in their ratings from Moody’s. These agencies had the audacity to state the new higher ratings did not reflect any change in the issuer’s credit worthiness. Yet no one was surprised when the arbitrary and one-sided upgrades resulted in significantly lower borrowing costs for the issuers and lower yields for the investors.
Contrast this artificial stacking of the deck in favor of government debt with how Moody’s and other ratings firms treat scores of public company issuers in the manufacturing and energy industries, including natural gas manufacturers.
There are scores of examples to choose from, but let’s select the company I work for: CNX Resources. CNX is the low-cost and high-margin manufacturer of natural gas in the northeast United States. CNX has been consistently free cash flow positive, is not highly leveraged, and is not faced with looming debt maturities in the coming years. Essentially, CNX is a creditor’s dream, offering healthy yields at a low risk of default. Yet Moody’s assigns a credit rating of B1, which under its scale represents “speculative” and “high credit risk.” Yet there are no data or quantifiable facts that support this view; the rating defies Moody’s ballyhooed objective analysis. Similar situations are evident across many companies in the natural gas, pipeline, and extractive industries.
If you placed Chicago’s and CNX’s financial metrics side by side on a sheet of paper without their names and asked a college freshman economics major to tell you which was higher credit risk and which was lower credit risk, the answer would be obvious.
So why is it that Moody’s, armed with thousands of bright employees, over a hundred years of experience, and a supposedly objective quantifiable ratings methodology, determines that Chicago’s debt is more credit worthy than a company like CNX’s debt?
The answer to this disconnect is not obvious – and Moody’s has done nothing to shed light on the answer. One is left to assume that Moody’s is blindly accepting the orthodoxy that fossil fuels are on the way out, soon to be replaced by so-called renewables, and therefore the entire fossil fuel industry is an elevated credit risk. Yet there is no math or science backing the blind faith in the supposed looming evaporation of the need, demand, or market for natural gas.
Reality—and numerous forecasts—dictates that natural gas is going to play the leading global role in electricity generation, transportation, and manufacturing for decades to come. Moody’s delusional zealotry will not change that reality; it will only delay its benefits for millions of humans desiring improved quality of life.
With Moody’s and other ratings firms, it is no longer first and foremost what your financial metrics are that determines your rating, access to capital markets, and cost of capital. Instead, it is what your entity does for a living and whether that endeavor is judged to be favorable or unfavorable through the lens of the ratings firm’s politics, ideology, and beliefs.
If you are lucky enough to be a coastal state or urban government that outspends budget year in and year out facing certain default in the future, Moody’s is more than happy to place its hand on the objective scales to push ratings in your favor, because Moody’s deems you one of the good guys. If you are a subsidy hunting, rent seeking renewable company feeding at the taxpayer trough and that can’t show a sustainable business model without such subsidy, Moody’s gladly assigns you ratings superior to your metrics in the name of saving the planet. Conversely, if you are unfortunate enough to be a government entity that operates within its budget or a company in the noble natural gas industry that thrives without subsidy, you run the risk of discrimination when your credit ratings are arbitrarily penalized. All because the ratings firm doesn’t consider what you do or how you operate as worthy. This is elite arrogance at its worst.
Credit ratings firms have a sorry history of missing financial calamities even as they are unfolding despite clear warning signals (look no further than the 2007 – 2009 global financial crisis). Distractions of playing judge and jury on what’s worthy and just makes matters worse and is a disservice to investors, issuers, and the economy. These ratings firms should immediately drop the subjective and ham-fisted attempts at social engineering and capital redistribution. Instead, they must return to their fiduciary duty of providing objective, transparent, and consistent ratings using quantifiable processes. If these firms refuse to do so, it is time for all market participants to seriously question the purpose and need for ratings firms.