Doubly Bound: The Cost of Credit Ratings

Rating Fees

Rating Fees

THE TOTAL AMOUNT US MUNICIPAL BOND issuers pay for credit ratings is not reported, but can be roughly estimated. The two largest rating agencies—Moody’s Investors Service and Standard & Poor’s Rating Services—are owned by US-based public companies: Moody’s Corporation and McGraw Hill Financial, respectively. These corporations must file quarterly and annual reports under SEC rules, but they have broad discretion in how they report revenue by business segment. Since these companies engage in many activities other than rating US municipal bonds, their top line revenue figures are not useful for the purpose of determining how much these firms charge state and local governments and not-for-profit bond issuers. 

McGraw Hill’s 2014 Form 10-K34 filing shows that the company earned a total of $5.05 billion in revenue of which $2.46 billion was attributable to S&P Ratings Services. The company does not appear to further segment this rating revenue between structured, corporate, and government categories.

Moody’s provides much more granular disclosure. Its 2014 Form 10-K35 shows $3.33 billion in revenue of which $2.25 billon was associated with credit rating activities. Moody’s further breaks down its rating revenue into four sectors: corporate finance, structured finance, financial institutions, and PPIF (public, project and infrastructure finance). This last segment, which accounted for $357.3 million in 2014 revenue, includes both US and foreign public-sector borrowers. Moody’s further breaks out PPIF revenue between US and non-US sources. In 2014, the company reported $226.2 million in US PPIF revenue, up from $215.4 million the previous year.

Assuming that S&P’s revenues are similar and that Fitch36 earns between a third and a half of its larger rivals, I estimate that US municipal bond issuers paid somewhat more than $500 million for credit rating services in 2014.

A large fraction of this $500 million takes the form of profit. According to Moody’s Form 10- K, the overall company had an operating margin of 43.2 percent. More relevant to this inquiry, Moody’s ratings business reported a 52.2 percent operating margin. Expenses and margins are not broken down by rating sector, and it is likely that the margin in the US Public Finance unit is lower than elsewhere within Moody’s Investors Service because fees for government credit ratings tend to be lower than those for privately issued bonds.37

S&P’s 2014 profit performance was much worse than Moody’s, but this is primarily the result of legal and regulatory settlements booked by the company in 2014. In all, McGraw Hill recorded $1.6 billion in charges associated with S&P’s settlements with the Department of Justice, states’ attorneys general, CalPERS and the US Securities & Exchange Commission. None of these settlements related to US municipal bond ratings. Margin information is not available for Fitch.

Assuming that the three agencies enjoyed an average profit margin of 40 percent, I can conclude that $200 million in municipal bond ratings revenue fell to the corporate bottom line—reflecting a substantial transfer of wealth from municipal stakeholders to private interests.

The micro impact of this transfer was captured in a 2011 Bloomberg story38 focusing on West Haven, Connecticut. The city paid S&P and Moody’s combined fees of $31,700 to rate a $45 million bond issue. Author Zeke Faux estimates that fee would have covered nine months’ salary for one teacher in a city that had recently laid off fourteen teachers.

Ratings fees charged to individual governments are generally not publicly reported.39 According to a November 2014 ratings fee disclosure published by S&P40, that agency generally charges between $7500 and $495,000 per municipal bond offering based on sector, par amount, structure, and complexity of the transaction. With the increased availability of open government checkbooks and the opportunity to perform public records requests, researchers will likely gain more insight into ratings fees paid by individual governments.