The Rating Agencies Blow, but We Knew that Already

As Gretchen Morgenson points out in her recent Fair Game column, the overseers are all complicit for the current economic mess. Put in this category the regulators (think SEC, the Fed, etc.), the Boards of these failed financial companies (who didn't understand the products they were pedaling), and the rating agencies. Today lets look at the latter and figure out why anyone cared about their ratings anyway.

Rating agencies rate debt issues. They analyze the risks and assign a grade representing your likelihood of getting your principal and interest back in full. Banks, as lenders and holders of debt make the same calculations when deciding who to lend money. Now, other than the big real estate debacle back in the 80's, lenders to companies have not had the meltdown like now. Why is that? I believe it's because they use more sophisticated devices than the rating agencies. How could this be? It's because they consider the signals from the public equity markets as well as balance sheet analysis.

When I was as banker, we used some type of Z score for our public company relationships. It would measure equity volatility of the target creditor. If the entity's stock was tanking or simply volatile, or low compared to it's competitors, we would stay away from any type of credit exposure, including swaps of any kind. As we have seen with AIG and Lehman Bros, the debt is as exposed as the equity when things go bad.

Lesson, not all is what it seems, only the Gov't is a AAA+ credit because it can tax and print money, so if you want safe try Treasuries, otherwise consider the equity risk of a company who's debt you are investing in, if you want to sleep more soundly.

Equity Might Be Out There For You

In my Angel discussion last week, I discussed the slow-down in angel investing in 2007, presaging if not anticipating the slow-down in the financial markets this year. Apparently, while following more cautious principles than in the internet hay-days, the professional investing markets are looking forward, and making investments in selected sectors. As discussed in James Flanigan's Entrepreneurial Edge article today, equity capital is available for the right story.

One sector discussed is mobile communication devices and related software. This is clearly a growing industry in the US and something that will need continued investment. It promises solid returns for early investors, and the professional investment firms, including private equity and venture capitalists are focusing here. Likewise, "green" technologies are getting favorable attention.

So it does seem that it's harder to raise debt these days, ergo , if you have a candidate do seek out the professionals (as long as you have a technology or "green" startup, that is)!