Morningstar Credit Ratings’ Vickie Tillman Talks Rating Agencies

Ms. Tillman: I worked for the City of Jersey City—I worked for city government. I heard about these things called rating agencies. I don’t think they were that well known at the time, but they were hiring people who understood city government and public finance. A friend of mine had actually joined them and said, “Why don’t you go for an interview?” I said, “Fine, I’d rather live in New York City than live in Jersey City”—although Jersey City has changed considerably since I lived there—so I came in and I interviewed and I got a job. I was literally an entry-level analyst at Standard & Poor’s municipal bonds group, and it was a growing time in public finance because [there were] things like federal programs for construction grants and matching programs to build clean water and clean sewer facilities.

It was also very interesting being a woman in finance [in the late 1970s and early 1980s], depending on what city you were dealing with; you would call them on the phone and get very different reactions.

Like what?

I’d get questions like, “Why are you calling me? Women belong in the kitchen, not in finance.” In public finance, what you do is visit these cities because seeing them and meeting with government officials is very important to get the sensibility around politics, because politics very much impact the financials of a city. There were times when I went on trips, and I would get out of the car or go to a meeting, even when I was the head of public finance, and they’d address the guy who worked for me—initially, they would assume the guy was in charge. But really, in the rating agency world, as it grew, [it] really became one of the more equal opportunity places for women. Not that there weren’t challenges, but people were really looked at based on their analytical skillsets. When I was growing up at Standard & Poor’s, especially in public finance, you need to reflect the communities that you’re dealing with, so very early on the idea of diversity was a very important element. Once you start going up the line there were different political issues, but in general, I think in finance, that was more of a place where you felt comfortable being a woman than I would imagine [in] investment banking.

It was a fascinating experience at [Standard & Poor’s]. I ran the public finance department and then I was asked to take over structured finance when structured finance first started. I ran that for about six years. Structured financing then was pretty plain vanilla. Then all of a sudden, it was only after I left structured finance and became the head of the global ratings business, did you start seeing the more complex securities coming out. In 1999, I became the global head of the ratings business for Standard & Poor’s and was there for about 10 years.

So you were there right through the downturn?

Well, I was there for a number of interesting events. Not just downturns. I was there for Enron, I was there for Parmalat, which happened in Italy. I was there during Savings and Loans. Actually, as an analyst, I was there for Executive Life, which was a big insurance company going default. So I had seen the ups and downs of the market, but I will say the credit crisis is something that even I never experienced because it was so national, so deep and affected globally a lot of different players.

Is that part of the reason you wanted to move on and try something else for a bit?

Initially, my thoughts were that I really wanted to make sure that people understood the Standard & Poor’s position and get the concept out there of what a rating is. A rating doesn’t speak to pricing, it doesn’t speak to liquidity: It speaks to credit. And that yes, in hindsight, we probably made some—I would say this across the board for rating agencies and the industry in general—assumptions. The view of the housing market was just blown to pieces because of the national housing crisis and the fact that you had a lot of securitizations that were pools of pools of pools of residential mortgages. I wanted to really make clear, as head of ratings, that while people presupposed that all we did was look at housing appreciation, in fact what rating agencies did was actually stress test it and look at the housing market depreciation. No one thought the housing market was going to continue to grow.

I think what the rating agencies learned was that they had to maintain and make sure that people who participated in the marketplace who used ratings understood what a rating was and what it was not. I think rating agencies have to take ownership in ensuring what the rating speaks to and what it doesn’t speak to and I think investor education was something that everybody learned after the crisis, that you not only had to give really transparent information about how you rate a deal, but you have to include in that a lot of investor education. Albeit, in the structured market initially it was very highly sophisticated investors and then ultimately as the market got larger and larger you had a bunch of pension funds investing in it, and I think it really struck home—literally homes—in that people were caught in a situation where they were personally impacted. It was a perfect storm.

What about commercial deals?

Commercial mortgages and a lot of asset-backed deals actually faired very well in the market. Right now, [the] Dodd Frank [Wall Street Consumer Reform and Protection Act] is approaching—this is my opinion—and it’s a broad swath of regulation that is more ‘one size fits all,’ which is not necessarily the case in the capital markets. What we’re seeing now is different types of regulation, whether it’s from Basel III or some aspect of Dodd Frank, headed in the right direction but [the combination] has unintended consequences. I think that’s why right now you’re seeing some real struggles in the capital markets, and it’s really important that people understand that securitization in and of itself is a very economic way of getting financing to small- and medium-sized businesses. It creates economic growth. That doesn’t say that there not some very questionable structures out there, but the concept of securitization is really around the economics of getting capital into the marketplace to allow for economic growth to happen. Without that you tend to see it not siphon down into the middle classes, or the tertiary and secondary markets.

What does your role at Morningstar Credit Ratings entail?

So I’m the president of Morningstar Credit Ratings, and [the company, formerly Realpoint] was acquired by Morningstar Inc. out of Chicago [in 2010]. It primarily provides different kinds of value-added information so investors can make a good decision on their investments. We have a little bit of a different business model than the rest of Morningstar. We provide the credit ratings, and right now Morningstar Credit Ratings is in structured finance—commercial mortgages, residential mortgages and asset-backed securities and we primarily focus on the U.S. market. Morningstar Inc. has a business called corporate credit research and it’s the umbrella for corporate ratings, financial institution ratings and insurance ratings and we have a draft application in to the [U.S. Securities and Exchange Commission] to expand our purview into corporates and financial institutions, and the NRSRO. The way it works in the United States is you have to get a license for structured finance, you have to get a separate license for corporates, you have to get another license for financial institutions and another license for insurance for it to be considered an NRSRO.

We want to be a full-service nationally recognized statistical rating organization and be able to give a more unique kind of analytics to the marketplace than what had traditionally been dominated by the big three [Standard & Poor’s, Moody’s  Investors Service and Fitch Ratings].

Do you have any idea of when that’s going to happen?

It’s really up to the SEC.

What’s your day-to-day schedule like?

My day-to-day really is operating [strategically] in growing the business—and in terms of growing the business my No. 1 priority is the quality and integrity of the ratings and being very transparent in how we got to the ratings. I use the term “having an open kimono,” so if an investor is looking at what we write, they get our opinion of why and they get the appropriate level of information. Everybody who plays in the marketplace looks at different levels of information so we have to make sure we’re hitting all segments of who utilizes ratings.

We can be flexible and innovative in the way we talk about our opinions. We don’t have legacy issues. It’s good—I like to have experienced people in the groups that have been through the ups and downs because you don’t want to navel gaze in this industry. You want to be able to step back and have an objective observation, so a lot of the hires we’ve made are very experienced people who have been through the ups and downs of the marketplace, and that just brings that level of understanding of how markets evolve and how quickly markets can change. It gives the analyst the ability to ask more insightful questions. We’re out there to bring those insightful opinions to a marketplace that may be used to getting boilerplate responses.

As a rating agency, how are you preparing for regulatory changes, like risk retention?

We prepare just by being on top of what the regulations are and talking to the people that are looking at alternative structures to meet the regulations and understanding those, and being prepared that in the event that a certain structure emerges that is new and we haven’t seen before, that we have the knowledge and understanding to be able to give our opinion on it. We’re on the one side, whereas the other market participants are trying to figure out how they do risk retention. On the other side, part of the strategic aspect is, especially in commercial mortgage-backed securities, in 2015 it was about 25 percent of the whole commercial real estate market. That means there are other players in the real market because there’s an awful lot of commercial real estate, so part of what I look at is how can we service not only those who come to market from a structured perspective, but what if it’s a REIT [real estate investment trust]? What if it’s an insurance company that is doing whole loans? Can we develop appropriate approaches to start looking at other types of lending in that marketplace so that we can give our credit perspective not just in the securitization market but in the whole loan market, the corporate market, the bank loan market or the collateralized loan obligation market? My job is to understand how things are moving and have the right people around me so if [the market] does go a certain way, we [can] be playing in that space. We want to be innovative in how we play in that space.

Are you hearing of any interesting new structures from commercial real estate players?

We’re hearing a variety, although we haven’t seen anything. The first thing that came out is that you have a B-piece buyer that buys at the bottom end of a commercial securitization, and then the B-piece buyer would take on that bottom 5 percent of that retention, which would give them more control over the structure of the deal. We’ve heard about that potentially happening, and we’ve heard about people saying that issuers aren’t going to be excited about that because they won’t be able to control all the structuring. And does the B-piece buyer really want to hold that 5 percent retention?

We’ve heard of what they call a vertical stack, where a bank would issue the deal, but instead of the 5 percent retention at the bottom of the stack, which is usually the most credit-sensitive, you could take a small piece of a AAA and a small piece of a AA…and that’ll add up to the 5 percent, and then they’ll be more comfortable holding on to that because they’re not holding on to the riskiest piece.

[But] nobody yet has really come to the market with anything that is particularly new.