Egan-Jones Ratings

Overview: The Egan-Jones Ratings Company is a privately held ratings agency headquartered in the Philadelphia suburb of Haverford, Pennsylvania, named for its founding partners and employing only 20 persons. Long after all major competitors moved to being compensated by the companies or government entities whose securities they rate, Egan-Jones has clung to the older model of being paid by the users of its ratings and research, a stance which promotes much greater independence and objectivity, while removing conflicts of interest. Egan-Jones focuses on rating corporate bonds, and its primary client base consists of buy side securities analysts and money managers. The firm issues ratings on approximately 1,000 issuers, spanning the spectrum from investment grade to high yield bonds.

Founded in 1995, Egan-Jones is now one of 9 Nationally Recognized Statistical Ratings Organizations (NRSROs), pursuant to a July 2008 application.

Methodology: Egan-Jones claims to use an “unbiased, rules-based methodology” that is completely uninfluenced by users or by issuers. The firm has a unique system of subjecting its own ratings to what it calls a “hits and misses” analysis. This attempts to measure the degree to which ratings market leaders Standard & Poors and Moody’s converge towards the ratings issued by Egan-Jones. Since 2001, the annual “hits and misses” ratio has ranged from 94% to 97%, covering between 293 and 513 ratings issued per year. The chief flaw in the “hits and misses” analysis is that it does not necessarily reflect how accurate Egan-Jones actually was in judging the risk inherent in a given bond issue or the creditworthiness of a given issuer, much more difficult concepts to capture accurately. Instead, this analysis can reward Egan-Jones for making erroneous calls if its chief competitors make the same errors.

Accuracy: Despite these caveats mentioned above, Egan-Jones cites several academic studies on its website that indicate a greater degree of accuracy than its larger and better known competitors. Among the findings of these studies are:

  • Downgrades by Egan-Jones are typically followed by 30 days of significant negative returns.
  • S&P; is much more likely to give a higher rating than Egan-Jones if the company in question has a new CEO or CFO, or has a lower percentage of past bond issues rated by S&P.;
  • Investor-paid ratings agencies like Egan-Jones issue more timely ratings than issuer-paid competitors.
  • Egan-Jones is found to be up to 237 days ahead of S&P; and Moody’s in their ratings changes by one study, and regularly 10 weeks or more ahead by another.

SEC Action: In April 2012 the Securities and Exchange Commission (SEC) charged Egan-Jones with overstating its expertise in rating asset backed securities and government debt in its 2008 application to be an NRSRO. Co-founder Sean Egan and his company agreed to settle the action for $30,000 and withdraw from rating these securities for 18 months. The firm’s application asserted that it had issued 150 ratings for asset backed securities and 50 for sovereign debt, as well as that it had rated both categories of securities since the firm’s inception in 1995. The SEC counters that Egan-Jones actually had issued no such ratings by that point in time. Additionally, the SEC asserts that 2 Egan-Jones analysts were rating securities that they owned; one of the 2 allegedly owned securities from at least 17 different issuers that he was rating. Since the firm mainly rates corporate bonds, the ban is not expected to have any significant direct effect on its business, but its reputation for independence and probity is bound to be damaged. (See “SEC imposes curbs on activities of rating agency Egan-Jones,” Financial Times, January 23, 2013.)

Meanwhile, none of the other NRSROs have been hit by similar probes or enforcement actions by the SEC, despite copious evidence of possible malfeasance that helped lead to the crisis. This has led to allegations by various financial columnists, as well as by Egan-Jones itself, that the SEC action is politically motivated, in retaliation for the firm’s July 16, 2011 downgrading of United States federal debt by one notch from AAA to AA+. Just two days later, the SEC’s Office of Compliance, Inspections and Examinations demanded an explanation. S&P; followed with a similar downgrade a month later, but Moody’s and Fitch did not. (See “SEC Sues the One Rating Firm Not on Wall Street’s Take,” by William D. Cohan, Bloomberg.com, September 30, 2012.)

On the other hand, it should be noted that another arm of the federal government, the Department of Justice, filed a $5 billion suit against S&P; on February 4, 2013. Follow the link to Standard & Poor’s further up in the text of this article for details.

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