“It’s hard to be the umpire when you’re being paid by either the batter or the pitcher,” Coffee says. He believes an agency will think twice about a harsh downgrade of sovereign debt if there is a risk of regulatory reaction. “A lower rating may mean billions of dollars of additional interest paid,” Coffee says. He argues agencies inherently “know where their self-interest is–and it’s not on the side of total integrity and independence.”
One school of thought has it that the financial world should simply rely on market data to rate debt. Investors such as hedge funds, who want to gauge risk on bonds, will often track the price of credit default swaps, which are essentially insurance policies purchased against the default of a lender. Some academics argue that the prices in the credit default swap market can be used in place of grades from ratings agencies. “Think about it like car insurance,” says Chayawat Ornthanalai, an assistant professor of finance at the University of Toronto’s Rotman School of Management, who has studied the swaps and their relation to bonds. “If I ask you what your car insurance premium is, and you say you’re paying $300 a month, I can kind of guess you might be a more dangerous driver than someone paying $100.” He concludes, “The market already has a better benchmark to judge risk.”
Curry, unsurprisingly, doesn’t agree. Ratings agencies are about legwork, he says, in particular, questioning management or governments on a regular basis. “What ratings agencies bring to the table is, to some degree, consultation with management: Here’s what we’re seeing. Are we missing anything? Have we misinterpreted something?” Curry says. “If we look at the European sovereigns with that background in mind…we don’t just react to the numbers.”
Curry points to Ireland. When DBRS rated that country’s bonds this year, it decided Ireland had a better handle on its debt situation than it was getting credit for, so DBRS did not slash the rating to B status, as the Big Three did, but lowered it just one notch. It was a decision that raised a few eyebrows. “Was Ireland good? No, Ireland was a mess,” Curry says. “We felt that it was a bad situation that they had pretty effectively stabilized.”
A byproduct of the Irish decision is that DBRS is now seen as contrarian. It is the friendlier rater in Europe–that one judge at the Olympics who seems to score a little easier when the gymnast doesn’t quite stick the landing. And because of that, DBRS is being watched more closely, and more skeptically, by the market. While multilevel downgrades have been common from Moody’s, S&P and Fitch, such a move from DBRS would be unusual and newsworthy, sending a chilling signal to the market. Soon after the three biggest agencies issue their ratings, the question becomes: What will DBRS do?
* * *
In the early evening on Aug. 8, DBRS issued the crucial decision. Spain was in financial trouble, yes, dire trouble, and in need of a downgrade. But not to the extent that the other bond raters believed.
Just as it had done with other countries in the embattled euro zone, DBRS lowered Spain’s credit rating, but with restraint, dropping the country’s bonds from A (high) to A (low).
Crucially, Spain wasn’t relegated to less than A status. There would be no triggering of billions of dollars worth of payments. Spanish banks had a reprieve. As the headlines would suggest in Europe the next day, Spain had dodged a bullet.
“We’ve got a different philosophy than the other agencies,” Walter Schroeder says. He makes no apologies for his outlier stance on European sovereign debt. But Europe is on the brink of financial ruin–so much so that the ECB in September dropped the requirement that all bonds used as collateral by countries like Spain carry a minimum rating, to make emergency funding more accessible. It was a reminder of the power that governments ultimately hold, and of how the European landscape is deteriorating. So is DBRS irresponsible in not slashing ratings?
“Just watch,” Schroeder says bluntly. “Let’s see how good we are three years from now. Let’s see what the ratings are then. And let’s see who’s right.”
He has, in other words, just issued a challenge to every other ratings agency–and the market. They have it wrong. “Most of the countries in Europe are basically strong, there’s no reason they can’t get out of their problem,” Schroeder says, citing the case of Italy. “We don’t think that warrants cutting the thing four rating categories. Why all of a sudden are you cutting it that many grades?”
Wild swings only imply that your original analysis was wrong, he maintains. “When we do it, we mean it.” That is why DBRS is now a critical cog in Europe. Schroeder has built a business on trying to predict the future by analyzing the present. And given the ratings that DBRS has issued this year, the reality of the present is plain and simple: There are governments across Europe hoping the upstart credit rater from Canada is not wrong.