Three’s company

A convivial French entrepreneur with a penchant for deal making may not seem the obvious challenger to the two US firms that have dominated the global credit ratings business for decades.

But that is the role astutely embraced by Marc Ladreit de Lacharrière, boss of Fimalac, a Paris bourse-listed industrial and financial conglomerate that he founded only nine years ago.

With a dazzling series of acquisitions, he is creating a credit ratings business that can be a serious third force in a market where Moody’s Investors Services and Standard & Poor’s Ratings Services have an 80 per cent share between them.

Although chary of predicting that his own ratings firm, now known as Fitch, will become the equal of the “big two,” Mr Lacharrière’s ambition is to build it “into a worldwide agency… that will be as close to them [in shares of global rating revenues] as possible”.

It is a goal that is surprising not least because, as Mr Lacharrière readily admits, credit ratings are still not widely understood in France, or even in Europe generally. They were even less understood when he made his first significant foray into this business during the early 1990s with the purchase of a relatively modest, London-based bank rating agency called IBCA.

However, western Europe has now become the fastest growing region for credit rating activity as companies there have started to shift the source of their financing from bank loans to the capital markets. Credit rating revenues are up 35 per cent in Europe this year.

And, with the US market maturing, Europe looks set to be a prime battleground between Fitch and its two big competitors. In this arena, at least, Mr Lacharrière is set on matching them. Credit rating in Europe is underdeveloped.

“There is a lot of room to expand. So it is the right moment for us,” says Fimalac director Véronique Morali.

Although chairman Lacharrière tends to emphasise Fitch’s European ownership, well over half its 1100 staff are today US based following acquisitions there; and the agency is run jointly from London and New York.

Latest of Fimalac’s acquisitions, announced in October, is BankWatch, a ratings business until then owned by Thomson Corporation, the Toronto-based electronic information provider. The purchase, which is still being finalised, is thought to be costing Fimalac some $40–50m. On completion of the deal, BankWatch will be merged with Fitch, while Thomson Corporation will get 3.4 per cent of the enlarged rating agency.

This acquisition follows the merger of US ratings agency Fitch Investor Services, with IBCA, in a deal unveiled during October 1997 that cost Fimalac $175m; and this year’s $528m takeover of Duff & Phelps Credit Rating by Fitch IBCA. All this merger activity will leave the enlarged Fitch about half the size of Moody’s and S&P , with about 20 per cent of the estimated $1.5bn annual global rating revenues.

However, things could have worked out rather differently if Mr Lacharrière had not steadfastly resisted offers for IBCA from all the three credit agencies that Fimalac has acquired since 1997. In the summer of that year, the late Bob Van Kempen, then chief executive officer of Fitch, flew to Paris in a bid to buy IBCA.

In the course of discussions during the subsequent two months, the proposed deal was reversed. It was Fitch’s owners, the Van Kempen family, which decided to sell. Mr Lacharrière now had the building blocks for constructing a third force in the global credit ratings business. “The marriage between Fitch and IBCA made a lot of sense.

They were totally complementary from a geographic point of view and in terms of product lines. They were a perfect fit,” says Ms Morali. About the same time, Paul McCarthy, chairman of Duff & Phelps, also made the pilgrimage to Paris with an offer for IBCA. Three years later, it was again Mr Lacharrière who emerged as the buyer.

And just a year ago, it was Thomson that was knocking on his door with a takeover proposition for his rating business. “I was never tempted to sell IBCA,” says the 60-year old Mr Lacharrière, a patron of the arts in France, who started his career as an investment banker at Banque Indosuez and was managing director at French cosmetics firm L’Oréal in 1991, when he decided to establish his own company.

Today, Fimalac, with a market capitalisation of €1.5bn, has interests (apart from credit ratings) ranging from bulk chemical storage to hand tools and designer furniture, and from mailing equipment machines to precious metal processing. It is a mix that the Fimalac boss characterises neatly as industrial services products and financial products.

Dismissing suggestions that it represents an incongruous combination of business activities, Mr Lacharrière insists that the broad range of interests are Fimalac’s strength. But, despite his strong commitment to the credit ratings subsidiary, can Fitch really become a significant third force in an industry widely viewed as oligopolistic?

“There is a clear market wish for more competition in the credit rating industry, and we have to provide it,” answers Robin Monro-Davies, the chief executive officer of Fitch, in London, and the person with the task of welding the newly acquired rating agencies in to a coherent global force.

Credit rating is the only part of the capital markets where you see the degree of concentration obtained by S&P and Moody’s, which Mr Monro-Davies describes as a “powerful oligopoly”. The market’s dislike of this situation will help Fitch, he adds. Until recently, the smaller rating agencies were competing with each other, something that worked to the advantage of the two big agencies.

“Following the mergers, Fitch is the one that can compete. The shareholder has given us the resources to get the mass. Now we have to be the good competitor,” says Mr Monro-Davies.

There is no expectation that Fitch can soon be of a comparable size to the big two agencies, or match them in all products – rating companies, banks, insurance firms, as well as structured, sovereign and municipal debt – everywhere in the world.

“It would not make sense for us to try to rate 1500 US corporates, as S&P and Moody’s do. But there are clear areas where we have a natural strength,” says Mr Monro-Davies. In the product area, he cites structured finance and bank ratings. “There is no reason why we cannot be the leader in these sectors,” he asserts.

Fitch also has relative strength in some industries, such as telecoms and utilities, helped by the acquisition of Duff & Phelps, which has built up in those areas. Geographically, Fitch can reasonably aspire to rate as many European companies as the big two agencies, as well as be a prime competitor in Latin America.

“What we should be able to do,” says Mr Monro-Davies, carefully choosing his words, “is to continue to take market share away from S&P and Moody’s, as we have for the past 10 years.” And, at a time when the credit rating market is expanding (20 per cent annually in the past five years), he would regard this as a very satisfactory outcome.

It is not an outcome he could have dared predict in 1978, when he set up IBCA as a bank rating agency in the wake of various bank crises that shook the financial world in the early and mid-1970s. Initially part of stock brokers Fox-Pitt, Kelton, which specialised in bank and insurance company shares, IBCA was subsequently spun off, and run by Mr Monro-Davies and a couple of staff from one room of Eldon House, close to London’s Liverpool Street Station.

Only in the late 1980s did IBCA begin rating European companies, and in the mid-1990s, countries. Today, just the London end of the rating agency controlled by the urbane, 60-year old Mr Monro-Davies occupies all six floors of Eldon House.

As well as dual headquarters in London and New York, and a substantial office in Chicago, Fitch has 24 offices or joint ventures around the world, and is setting up a local rating agency in Thailand, as well as negotiating to take a minority stake in South Korea’s leading rating agency, the Seoul-based KMCC.

Altogether, the business will generate rating revenues in 2001 of some $300m and earnings of $80m, predicts Mr Monro-Davies, a former Fleet Air Arm pilot. Based on a multiple of 12 to 15 times earnings, that gives the company a market value of about a $1bn. Predictably, both Moody’s and S&P insist that Fitch is not a serious threat to their market positions.

Fitch, they say, does not have the range of products offered by the big two, nor their experience – with S&P, for example, undertaking its first credit rating, of a railway company, in 1916. “To be a global player, you must serve markets globally,” says Robert Becton, a Moody’s managing director, in New York.

“We treat all our competitors with due respect, based on the markets they serve.” However, Moody’s has 100 years’ experience and “that track record is what investors have come to rely on,” he adds. It is a sentiment echoed by Vickie Tillman, executive vice-president and chief rating officer at Standard and Poor’s in New York.

“The level and depth of experience that we have, and the number of people we have, often working on very sophisticated transactions, is something you can’t buy,” she says. “With this experience and the quality of the service S&P provides, we expect to continually raise the barriers to entry that [other agencies, such as Fitch] face in this business.”

While both S&P and Moody’s can point to their long pedigrees, the rating industry has changed greatly in the past 100 years, and is still changing rapidly.

The industry in its modern form only dates from the later 1960s (the agencies began charging companies for ratings then: previously their fees came from research). Only in the mid-1980s did the big two agencies start to build up their international operations. In the case of Moody’s, ownership has also changed.

It was spun off from Dun & Bradstreet Corporation, the New Jersey credit information firm, in September, and floated on the New York Stock Exchange. Now, with the greater transparency that comes from being a public company – it had a market capitalisation of $4.2bn in early November – Moody’s reveals revenue running at an annual rate of $588m during the first nine months of 2000 (87 per cent from rating fees), and net income at an annual rate of $158m.

S&P, a subsidiary of US publishing group McGraw-Hill, still does not disclose such figures. But they are assumed to be roughly similar to those of Moody’s.

Although the US capital markets are likely to remain vital sources of revenue, accounting for some 70 per cent of total revenue at all three leading rating agencies, growth there is slowing down.

It is the much faster growth expected in the rest of the world that has led to a scramble to set up offices in key countries or, in some cases, take over local rating agencies or enter into joint ventures with them.

Even this process appears to have passed its peak, with all three leading credit rating agencies now operating extensive international networks. S&P, for example, has 21 overseas offices and eight affiliates. Moody’s has 16 offices.

There may be the occasional strategic gap in the network to fill, such as Fitch’s recent collaboration arrangement with Japan Rating & Investment Information (R&I), the largest rating agency in the country. But the countries that are sources of international bond issuance are mostly covered by the global rating agencies.

Whether Fitch can, as Mr Lacharrière and Mr Monro-Davies believe, become a third force in the global ratings business, eroding the domination of the two powerful leaders, will ultimately depend on the markets. The markets want to see more competition.

If Fitch can be a strong competitor, it will be giving the markets what they want, argues Mr Monro-Davies. That the markets will be the final arbiter is the one thing on which all three agencies can agree. “We will live with the market decision about whose ratings it wants,” says Moody’s Robert Becton, convinced that his agency’s track record makes it impregnable.

No less convinced about the ability of S&P’s ability to fend of would-be rivals, Vickie Tillman says the quality of analysis and service that her agency provides will always give it a comparative advantage. “This will be judged in the market,” she says.