DBRS offices on University Ave. in Toronto.Fred Lum/The Globe and Mail
Walter Schroeder was taking his family on a road trip from Toronto to Montreal in his Volkswagen Beetle 40 years ago when he conceived a plan to start a credit-rating agency.
By 2007, the company he founded, DBRS Ltd., literally had its name in lights – glowing red ones atop a tower in Toronto's financial district. It also grew into the fourth-largest rating agency in the world, next in line to the big three that dominate the game – Moody's Investors Service Inc., Standard & Poor's Corp. and Fitch Ratings Inc.
The financial crisis has shaken up the industry and Canada's homegrown credit-rating agency might soon be added to the list of domestic firms sold to foreign buyers. The firm, which is still controlled by the Schroeder family, has put itself up for sale, hiring New York-based investment bank Perella Weinberg Partners LP to find a buyer or explore its other options. Private equity firms are reported to be among those interested.
The potential sale speaks to the changes that have taken place in the ratings business in recent years, and to the fact that, despite all the new regulations governing the industry, these companies are still money makers. Regulators will have to stay on their toes as the industry finds new ways to keep up profit growth.
The industry's bread and butter continues to be charging debt issuers fees for rating their debt, a model whose inherent conflict is well known. But agencies have been stretching further in the hunt for new revenue sources.
A private equity player could potentially put new pressure on DBRS to bolster profit margins, while its business model and finances would continue to avoid the public scrutiny that Moody's and S&P face, since both ratings agencies' parent companies are listed on the New York Stock Exchange.
The sale of DBRS comes amid a new regulatory environment for these companies. Regulators are finally paying real attention to rating agencies, after highly rated securities cratered during the financial crisis. While the level of oversight has become intense in a relatively short period of time, it is also adding new costs and risks for raters. Nonetheless, the business still has its appeal.
"It's cyclical," said Ed Atorino, an analyst with Benchmark. "But it's a very good business on a long-term basis. As companies want to sell bonds, they need to have some kind of imprimatur on what they're doing."
Regulators in the U.S. are seeking to reduce that country's reliance on credit ratings, but ratings are still baked into the system in North America. Numerous Canadian laws and regulations explicitly require debt ratings and much of the financial sector continues to rely on them.
For Mr. Schroeder , who is now 72, the sale will mark a sentimental parting of ways with a business he set up to be a family legacy.
As the financial crisis percolated, Mr. Schroeder turned away unsolicited offers for his firm. But the stress soon took its toll, and friends began to worry about the pounds that were falling off his frame. Part of the angst came from DBRS's high rating on $33-billion of third-party asset-backed commercial paper that froze in 2007 as the financial crisis began to bite. It took years for that paper, known as ABCP, to be unwound. As the crisis snowballed, DBRS and all the major rating agencies came under serious criticism, at a time when their basic businesses were treading water to stay afloat.
DBRS shuttered three European offices in 2008, and its worldwide head count dipped to about 175, from 280 before the crisis. It tried to find new sources of revenue, such as impact assessments, where it tells an issuer what the rating impact would be following a major strategic deal.
Its head count is now above 350, the negative headlines have simmered down and Mr. Schroeder is considering options for the firm. A new owner with deep pockets could likely build on his success, and bolster DBRS's market share.
But any new buyer will have to be watched because competition in this business could actually be harmful, one of the many issues that regulators will have to grapple with.
A 2011 Harvard Business School paper found that as Fitch's market share grew significantly starting in the mid-1990s, the quality of Moody's and S&P's ratings fell. The paper noted that Moody's and S&P generally issued higher ratings, and ones less predictive of credit defaults. Whether they were looking to gain favour with clients in the face of heightened competition is an open question.