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The letter was entirely polite and businesslike, but something about it chilled Wilhelm Zeller, chairman of one of the world's largest insurance companies.
Moody's Investors Service wanted to inform Zeller's firm -- the giant German insurer Hannover Re -- that it had decided to rate its financial health at no charge. But the letter went on to suggest that Moody's looked forward to the day Hannover would be willing to pay.
In the margin of the letter, Zeller scribbled an urgent note to his finance chief: "Hier besteht Handlungsbedarf."
We need to act.
Hannover, which was already writing six-figure checks annually to two other rating companies, told Moody's it didn't see the value in paying for another rating.
Moody's began evaluating Hannover anyway, giving it weaker marks over successive years and publishing the results while seeking Hannover's business. Still, the insurer refused to pay. Then last year, even as other credit raters continued to give Hannover a clean bill of health, Moody's cut Hannover's debt to junk status. Shareholders worldwide, alarmed by the downgrade, dumped the insurer's stock, lowering its market value by about $175 million within hours.
What happened to Hannover begins to explain why many corporations, municipalities and foreign governments have grown wary of the big three credit-rating companies -- Moody's, Standard & Poor's and Fitch Ratings -- as they have expanded into global powers without formal oversight.
The rating companies are free to set their own rules and practices, which sometimes leads to abuse, according to many people inside and outside the industry. At times, credit raters have gone to great lengths to convince a corporation that it needs their ratings -- even rating it against its wishes, as in the Hannover case. In other cases, the credit raters have strong-armed clients by threatening to withdraw their ratings -- a move that can raise a borrower's interest payments.
And one of the firms, Moody's, sometimes has used its leverage to ratchet up its fees without negotiating with clients. That's what Compuware Corp., a Detroit-based business software maker, said happened at the end of 1999.
Compuware, borrowing about $500 million, had followed custom by seeking two ratings. Standard & Poor's charged an initial $90,000, plus an annual $25,000 fee, said Laura Fournier, Compuware's chief financial officer. Moody's billed $225,000 for an initial assessment, but didn't tack on an annual fee.
Less than a year later, Moody's notified Compuware of a new annual fee -- $5,000, which would triple if the company didn't issue another security during the year to create another Moody's payment. Fournier said Moody's didn't do anything extra to earn the fee. But the company paid it anyway -- $5,000 in 2001; $15,000 a year later.