Moody's List of Riskiest Companies Forgets to Include Moody's

This post first appeared on Minyanville.

Make-up calls belong in basketball, not finance.

In an attempt to render itself useful, Moody’s Investors Services (MCO) is issuing a list dubbed “The Bottom Rung,” cataloguing the riskiest 15% of all companies it tracks. The effort, which the company claims is an attempt to get ahead of the looming mountain of corporate defaults, has already ruffled a few feathers.

According to the Wall Street Journal, Eastman Kodak (EK), which appeared on the list, issued a harsh rebuttal last night, saying “Any speculation, however informed, suggesting that Kodak is less than financially sound is irresponsible.”

Among the list of allegedly shaky companies: Familiar names like Ford (F), General Motors (GM) and Chrysler made the cut, along with airlines AMR Corp (AMR) and US Airways (LCC). Retailers, restaurants and even a few energy firms also appeared in this corporate hall of shame, in addition to chipmaker Advanced Micro Devices (AMD) and chemical manufacturer Georgia Gulf Corp (GGC).

Moody’s, along with fellow ratings agencies Standard and Poor’s (MHP) and Fitch Ratings Services, played a major role in the recent financial market meltdown. Conflicts of interest with debt issuers, faulty models and lax internal controls all led to credit ratings that were unreliable at best, deceptive at worst.

Unfortunately for Moody’s, gone are the days when investors valued haphazard assessments of credit risk. The Bottom Rung, while generating ample work for Moody’s customer-complaints department, isn’t likely to reclaim any of the company’s lost glory.

When a firm that specializes in assessing whether borrowers will repay their debts fails to see the biggest wave of defaults in a generation, it’s safe to say that company isn’t very good at its job.

Minyanville's Jeff Macke said it best last week:

In an environment in which DC is creating and changing the laws of corporate governance on a daily basis, it’s simply lunacy to allow 3 groups complicit in the creation of the underlying problem to go on their merry ways while members of the House endlessly lambast bankers for being bankers. Take the gun away from the 5 year old; suspend the ratings authority of Moody’s, S&P and Fitch.

GM, Chrysler Hit Taxpayers Up for $10 Billion

This post first appeared on Minyanville.

There’s a disturbing pattern emerging in Washington’s merry-go-round of bailouts:

1. Congress pleads with taxpayers to support bailing out a troubled industry;

2. Taxpayers rightly demand to know what their hard-earned money will be used for;

3. Congress chooses expenditures that are palatable to constituents (new lending, protecting deposits, investing in renewable energy, etc.);

4. Congress doles out money, neglects to describe rationale to taxpayers.

In recent weeks, it’s become evident that the $125 billion being invested in banks isn’t likely to jump-start lending anytime soon, as we were told it would. Instead, it’s paying for mergers and executive bonuses.

Now, the $25 billion earmarked for low-interest loans to the auto industry for renewable energy projects is likewise being diverted from its proposed goal.

According to the Wall Street Journal, General Motors (GM) and Chrysler LLC are lobbying the Bush administration to siphon off a portion of the bailout money to help fund their proposed merger. Chrysler, which is majority-owned by hedge fund Cerberus Capital Management, would end up being gobbled up by GM in a complex deal that would require about $10 billion to cover integration expenses.

Integration expenses, translated into layman’s terms, means layoffs and plant closures.

To be sure, neither firm is exactly flush with cash, nor are they in terribly good standing with their creditors; the deal would help shore up the financial position of both.

Monday, Moody’s Investors Services (MCO), the ratings agency Professor Jeff Macke colorfully described as “a bunch of sub-par analysts with the ability to make press releases and the power to kill any company in America,” lowered its ratings on both GM and Chrysler. Moody’s fears liquidity will continue to deteriorate, and that both firms could face cash crunches next year.

Ford (F), the third of Detroit's 3 troubled auto-makers, has seen its debt fall well into "junk" territory, and is on review for further possible downgrades.

Chrysler, for its part, is no stranger to the government dole. In 1979, the company petitioned Washington for over $1 billion in government-backed loans to prevent bankruptcy. Touted as a success, the bailout resulted in massive losses for creditors and layoffs of around 50% of its workforce. It did, however, keep the company alive…so it could go on to build millions of gas-guzzling SUVs.

Unfortunately, economic conditions in both the auto and financial industries have deteriorated such that, without government assistance, both would be doomed to collapse. Even with government funding, however, the result may not be much different.

AIG May Capture Biggest Red Flag

This post first appeared on Minyanville.

If there was ever a Monday to skip that morning coffee and run on pure adrenaline, this is it.

As Lehman Brothers (LEH) and Merrill Lynch (MER) jockey for top placement in this morning’s headlines, American International Group (AIG) is dramatically staking a claim for the financial market’s biggest red flag.

Lehman and Merrill, already collapsed into the hands of bankruptcy courts and Bank of America (BAC), respectively, have well-publicized and largely understood troubles. Loaded up with securities tied to US mortgage debt, their capital bases have been eroded by losses and writedowns on bad assets.

Although losses have been hard to quantify -- due to obfuscation by management and underhanded accounting aimed at hiding the true extent of the damage -- most investors can at least wrap their heads around the issues.

The US’s largest insurer, on the other hand, is besieged by losses in its opaque credit products division and is rushing to sell assets and raise capital to stay alive. Professor Sedacca has been eyeing the firm as a potential cancer for weeks, in fear that its mammoth exposure to the credit markets may put the entire system at risk.

AIG has seen its balance sheet destroyed by losses on complex derivative instruments known as credit default swaps. The company sold these insurance contracts to other financial institutions that owned mortgage-backed securities, putting AIG on the hook for any losses that may occur. And they have indeed occurred.

Although many such obligations are yet to be paid out, the value of these assets have opened a gaping hole in AIG’s balance sheet.

The company, which has raised over $20 billion this year, is seeking another $40 billion. To that end, it's asked the Federal Reserve for a bridge loan to give it time to find the cash, according to the Wall Street Journal. AIG’s -- and indeed Wall Street’s -- concern is that ratings agencies Moody’s (MCO) and Standard and Poor’s may not wait around to downgrade the company's debt.

The New York Times reports the company may not last more than a couple days if such a downgrade were to occur.

AIG, and indeed all financial institutions, covet high credit ratings to keep their borrowing costs and capital requirements low.

Rating Agency Overhaul Falls Short

This post first appeared on Minyanville.

So much for accountability.

The Wall Street Journal reported yesterday of the striking of a preliminary deal between New York Attorney General Andrew Cuomo and Standard & Poor's (MHP), Moody's Investment Corporation (MCO) and Fitch Ratings.

Under the proposed settlement, the three major debt rating firms will change the way they're paid for evaluating non-prime mortgage-backed securities. No fines will be imposed for their role in the collapse in value of bonds they once rated as investment grade. Despite the billions of dollars lost as a result of their shoddy reviews, the agencies will not admit (nor be forced to admit) any wrongdoing.

Cuomo hopes the new plan allows rating companies to be tough on issuers, while still generating income. Simply, agencies will charge issuers for reviewing potential securities and, if selected to rate the deal, earn an additional service fee. Additionally, agencies must disclose on a quarterly basis which deals they've reviewed. It's expected the increased transparency will help investors better evaluate the relationship between issuer and rater.

While the new fee structure is a step in the right direction, it fails to address the root of the issue. As I noted earlier this year:

The problem is one of incentives. As long as rating agencies are paid by the issuers of securities rather than investors, they'll be financially motivated to hand out generous ratings. In the for-profit business of rating debt, business is awarded to the firm that provides the best ratings.

Any marginal benefit from increased transparency will be wiped out by the impact of higher borrowing costs. The new fee structure is likely to increases ratings-related expenses, which will no doubt be passed on to investors. Investment banks like Lehman Brothers (LEH), Goldman Sachs (GS) and Merrill Lynch (MER) -- already under intense pressure to sustain profit margins -- aren't about to shoulder the extra burden alone.

The rating agencies were an integral part of Wall Street's debt experiment gone wrong. Regulators had the opportunity to make a bold statement: That those responsible for the implosion of the credit markets would be held accountable. Instead, the lack of material change in the relationship between issuer and rating agency demonstrates the ongoing unwillingness of regulators to police the very markets they're charged with monitoring.

Professor Macke's take on Moody's and S&P is perhaps blunt, but not unreasonable: "[The rating agencies] don't have to justify the myriad 'one off' mistakes they've made over the years, but rather their very existence."