Jules Kroll, a corporate investigations pioneer whose namesake firm once pursued hidden assets linked to dictators Saddam Hussein and Jean-Claude Duvalier, relishes the idea of chasing down the major bond rating agencies: Moody’s Investors Service, Standard & Poor’s and Fitch Ratings.
The industry needs a shake-up, he said. And he’s trying to provide one, founding the Kroll Bond Rating Agency Inc. in 2010 with help from his son, Jeremy.
“Six or seven years ago, I began to understand how some of the incumbents went about their business. I was always shocked and disappointed at the lack of diligence they undertook in a number of areas,” Kroll, the firm’s chief executive, said in an interview in his New York office. “I had a bird’s eye view of what was going on in companies that defaulted.”
Warning signs, he said, included the amounts of prepayments and increasing levels of default.
In 2008, just as Kroll was about to retire — he sold his original firm, Kroll Associates and later, Kroll Inc., to Marsh & McLennan Cos. for nearly $2 billion in 2004 — the financial industry imploded.
“In March, Bear Stearns goes down. The subject of rating agencies came up and frankly, I was appalled at the absence of direct responsibility. With everything blowing up around me, I thought maybe there was a chance we could do it better,” said Kroll, who will turn 71 this month.
“Jules is an agent of change,” said Kroll Bond Ratings president Jim Nadler.
Kroll and his small staff made waves six weeks ago when Kroll Bond Ratings issued its first rating to a state.
Kroll rated Connecticut’s general obligation bonds AA — its third-highest ranking — with a stable outlook, matching the ratings of Standard & Poor’s and Fitch. Moody’s rates the GO debt Aa3.
Kroll won’t stop there, according to its chief executive.
“Other states got in touch with us after the study,” he said.
In mid-April, Connecticut sold $555 million of GO bonds, attracting $1.7 billion in orders from institutional investors.
According to state Treasurer Denise Nappier, because demand exceeded the bonds available, the state was able to reduce interest rates in the final pricing, saving $1.35 million over the life of the bonds.
Kroll hopes to capitalize on investor disaffection with the three major agencies in the aftermath of 2008 global financial crisis, when credit agencies took the heat for bestowing triple-A ratings on mortgage-backed securities that soured.
“It’s okay to trust a triple-A again,” Kroll Bond Ratings trumpets on its website.
Drawing on his sleuthing background, Kroll, a Brooklyn, N.Y., native who grew up in Queens, cited an absence of surveillance on the part of the big three rating agencies, which control about 97% of the market.
“Kroll Bond Ratings brings a fresh perspective to public sector credit ratings,” said Nappier, who expects other firms to join the fray. “Kroll’s entry into this market can only enhance the evaluation of Connecticut’s credit by encouraging these agencies to be more accountable to issuers and investors alike.”
Kroll concurs about the partnership. “She’s an innovative, pioneering treasurer,” he said of Nappier.
Nappier has long called for rating agencies to recalibrate municipal bond ratings to a single scale, which she said would help level the playing field between corporate and government issuers.
In October, Connecticut announced a lawsuit settlement with the big three agencies, in which $900,000 will apply as credits against the costs of future ratings.
After lobbying from state treasurers, Moody’s and Fitch began using single rating scales. Standard & Poor’s always argued that it had a uniform rating scale, but it has upgraded ratings in some public finance sectors after default studies and criteria reviews in recent years.
Nappier also criticized Moody’s in January, when the agency lowered Connecticut GOs from Aa2.
“In many ways, Moody’s action is going in the wrong direction,” Nappier said at the time, accusing it of “looking in the rearview mirror.”
As treasurer of capital city Hartford in the early 1990s, Nappier was one of the first public sector debt issuers to employ Fitch, when the agency was looking to crack the muni market.
Nadler said the Kroll firm’s five-member municipal team eventually talked with state officials after some networking.
“The idea of what we’re trying to do resonated with Connecticut,” said Nadler, 54, who lived in the state for many years and was the vice president for corporate development at Stamford-based General Re Corp. in its New England asset management division.
“Connecticut allowed us to showcase our more transparent analysis. It’s much more detailed,” Nadler said. “We provide more and better information, and more timely research. People tell us, 'We want you to be transparent, not just talk about transparency.’ We provide very balanced views, not only the state of the state, but we look to the future. We don’t have time to look in the rearview mirror.”
Nadler worked for Fitch during its expansion phase in the early 1990s, rising to executive vice president. He sees both comparisons and contrasts with Kroll’s push.
“When I was with Fitch, the atmosphere was more benign. Investors wanted to see more information but they were not upset. One of the big differences today is that investors have lost confidence in the incumbent ratings agencies,” Nadler said.
Kathleen Kennedy, a senior director in charge of investor relations and marketing, cited Kroll’s depth of experience in a variety of sectors, “not just with rating agencies, but different backgrounds as well.”
For example, managing director Gary Krellenstein, who joined in November from JPMorgan’s energy and environmental group, issued a preliminary report about the difficulties of assessing the effects of Marcellus Shale natural gas drilling in assigning a municipal credit. Krellenstein called the development “a new dynamic in the market.”
The Securities and Exchange Commission has recognized Kroll as a nationally recognized statistical rating organization, or NRSRO.
Kroll, like the big three, is paid by issuers to provide ratings, according to documents it filed for its NRSRO certification.
Kroll also rates bonds backed by commercial and residential mortgages. Since June it has issued 10 structured finance ratings. In addition, Kroll has another investigative firm in its stable, K2 Global Consulting, to conduct much of the research for Kroll bond ratings.
Muscling in on the big three agencies, however, will be difficult.
“I think there is room, yes, but it’s going to be challenging for any rating agency to gain market share,” said Alan Schankel, a managing director at Janney Capital Markets in Philadelphia. “They’ll have to gain a reputation with analysts, both buy side and sell side.”
“Looking at Fitch and how hard they’ve had it is an example,” Schankel added. “Personally, I think Fitch puts out a high-quality product, yet they’re an also-ran when it comes to townships, for instance. That’s a lot of people you have to talk to.”
Moody’s and Fitch said they welcomed competition, while Standard & Poor’s said it does not discuss competitors.
“We believe that the market benefits from a diversity of opinions on credit, and we support healthy competition based on ratings quality,” said a Moody’s representative.
A Fitch spokesman added: “Investors should have access to a variety of credit opinions — that is good for markets.”
Kennedy, who is also a former Fitch operative, cited a conference in Las Vegas where one investor considered a Kroll presale report “a must read … the first thing I look to.”
She said the privately held agency has responded to investor feedback, such as a request to include executive summaries with reports.
“We’re owned by investors, so it makes sense to listen to investors,” she said.
Pension funds and foundations own 40% of Kroll Bond Ratings, according to the firm.
A partial list of investors includes Bessemer Trust Co., RRE Ventures LLC, New Markets Venture Partners, value investor Michael F. Price, venture capitalist Frederick R. Adler, and power generation and transmission group LS Power.
Jules Kroll acknowledged what his firm is up against.
“Problems are good at presenting themselves,” he said. “We can’t be like the other guys. We always ask ourselves how can we do things better and how can we do them differently.”
One “legacy” challenge is systemic, according to Kroll and Nadler. The firm has been lobbying pension fund investors to broaden investment guidelines to include any NRSRO.
Historically, most investment fund guidelines require ratings — not merely reports — from Moody’s and Standard & Poor’s.
“It’s only good for the incumbents,” Kroll said. “It’s an impediment to anyone except Moody’s and S&P. It’s anticompetitive and very bad for investors.”
Kroll also cited the cost and time to adhere to all regulatory and compliance regulations “that have been implemented in good faith to correct the sins of the past.”
He also acknowledged a big intangible: “Just getting people to try something new.”
