DALLAS -- When the Texas Public Finance Authority last year sold a $156.5 million issue, few in the bond industry were surprised by how low most of the fees were.
Widely known for its penny-pinching, the agency had a bond counsel fee of $20,819 and other costs that were even lower. That was not surprising from an issuer that once negotiated its lawyer fees to less than 10 cents for every $1,000 borrowed.
But while the state's most prolific issuer has earned a reputation for being stingy on its cost of issuance, there was one area where the agency had little control: the fee paid for its double-A rating.
The $47,200 paid to Moody's Investors Service and Standard & Poor's Corp. was more than the authority paid its bond lawyers, financial adviser and the printer -- combined.
"In the past, we have attempted to explore the possibility of negotiating a fee," said Harry Whittington, a board member and advocate of lower issuance costs for the authority. "Each time, we were told that we were a captive audience.
"It's another example of overcharging, overreaching, that has been going on in this business for years," Mr. Whittington added.
Growing concern over the cost of selling debt has prompted some issuers -- large ones, especially -- to pay more attention to fees, but these borrowers are finding that everyone associated with a bond sale is not willing to compromise.
Indeed, rating agencies have been immune to pressure for lower fees, despite the fact that competition in the wake of the 1986 Tax Reform Act has driven spreads lower, issuers and municipal industry sources complain.
The reason, many say, is that Moody's and Standard & Poor's have a highly profitable monopoly that may change only if up-and-comer Fitch Investors Service increases its market share.
"If you take your car in for work, you get an estimate. If you need some legal services done, you get an estimate," said Minnesota Finance Commissioner John Gunyou, who also chairs the national debt committee for the Government Finance Officers Association. "On any kind of service, there is some kind of estimate. That isn't the case with the rating agencies."
Rating agencies and many of their customers are quick to defend the practices, saying the fees are reasonable becuase of the value they add to a transaction going into the multi-billion dollar bond market.
"The dollar amount of the bill is pretty minor compared to the other services you're buying when you issue bonds," said Mr. Gunyou, reflecting an argument the rating agencies offer. "I think you're getting a good value."
Even so, most interviewed said they expect Moody's and Standard & Poor's to be more competitive in their pricing. Many said that in markets where Fitch compeetes, the fees seem more moderate.
Uphill for Fitch
"I've noticed on some deals in California that where Fitch is involved, the agencies seem more price sensitive," said an investment banker in San Francisco. "The issuers in those cases find that they are paying the same for three ratings that they used to pay for just two."
But Fitch is not a factor for much of the bond market.
Of the $172.58 billion in long-term municipal debt sold in 1991, 80% was rated by Moody's and Standard & Poor's, according to Securities Data Co./Bond Buyer. Fitch estimates that it rated about one-third of that market share, but even then it represented only about 2% of all issuers.
"Our goal is to be more general market," said H. Russell Fraser, president and chief executive officer at Fitch. "We are having an impact, because our competition is at least acknowledging that we are there."
However, when asked if the presence of Fitch was affecting his firm's pricing policies, Daniel Heimowitz, executive vice president and director of public finance at Moody's, said. "We believe our fees are equitable. We have made no fee changes or accommodations on the basis of a competitive environment."
But Mr. Fraser and others believe Moody's and Standard & Poor's are adapting to competiton. And, if Fitch has its way, the way rating fees are determined will changed.
"One of our goals is to see issuers charged more on the complexity of the deal, rather than the size," he said.
For instance, a $15 million transaction may be more complex than a plain vanilla general obligation deal several times its size, requiring more dtailed analysis.
Yet he admits there are limits. "On a $15 million issue, how much can you realistically charge?"
Major issuers like that idea. Many complain privately that rating fees now are tied to the size of the deal, and several said they favored a flat annual fee for agencies that are in the market several times a year.
The issuers have a point. In Texas as, for example, agencies in fiscal 1991 sold 14 issues totaling $1.53 billion, and they paid a total of $466.900 to rating agencies -- for an average cost of 67 cents per $1,000, according to state figures.
While the Texas Bond Review Board publicizes such statistics, executive director Tom Pollard says few eyebrows are raised over the figures. "It hasn't received much scrutiny," Mr. Pollard said. "I think it's going to get more scrutiny."
Others say an annual flat fee structure makes sense because rating agencies assume the least risk of all parties being paid out of bond proceeds.
"I can see getting paid in tandem with the size of the deal, but only if you assume some risk" said one city official. "The bond counsel has some exposure, so their fee should slide up or down with the deal. The rating agencies have little risk here."
But Fitch may be several years away from breaking the two larger rating agencies' perceived monopoly. Mr. Fraser admits that a Fitch rating alone is not received as strongly in the markets as Moody's or Standard & Poor's.
Gushing Money
"I'm not saying that with just our rating there isn't a penalty, because there is," he said, referring to a small disparity between the pricing of bonds rated by Fitch in conjunction with another agency and bonds rated by the larger two firms together. "But the penalty is getting smaller."
As Fitch grows, it could threaten its competitors' bottom lines. Officials at Moody's and Standard & Poor's declined to discuss their revenues and profits, but Mr. Fraser said that historically the agencies have earned pre-tax profits in the 50% range.
"I think the business is a lucrative as ever," he said. "That's why they don't like competition."
At the same time, some issuers believe the agencies are more profit-minded than before because of pressures from their corporate ownership.
"I see much more of a willingness to adjust their fees than in the past," said Michael Bell, chief financial officer for Atlanta. "I'm not saying we're being gouged. I'm saying they seem to be more attuned with how many hours they spend on an issue."
For their part, the established rating agencies defend their fees, saying that issuers are not only gaining market acceptance because of their ratinges, they are also paying for long-term surveillance.
"The cost of the rating is minuscule compared to the size of the cost of the issue, and we feel our ratings add value to the issue," said Glenn Goldberg, a spokesman at Standard & Poor's. Later, the added: "I don't know too many people who are happy about the bills they pay for anything."
Mystifying Assessments
Besides, he said, when Standard & Poor's issues a rating, it is agreeing to monitor the bonds until they are retired. "It may be 10 or 30 years," Mr. Goldberg said. "That's the best value."
But some issuers remain mixed about the rating fees, if only because they don't understanding the fee-setting process.
"I don't think they explain it well enough to the borrowers," said Sam Katz, co-chief executive officer at Public Financial Management Inc. in Philadelphia, a leading financial adviser. "When I am asked the question by a client [as to] why they are paying this certain fee for a rating, more often than not, my answer is that I don't know."
Fees are not determined by analysts, but by a separate group of people who determine what to charge based on the size, complexity of the deal, and the frequency with which the issuer comes to market.
Mr. Heimowitz said Moody's is letting issuers know they can meet in advance to discuss likely fees and the rating process. "We are encouraging people to call us," he said.
Mr. Gunyou said, "It's a question of, Who are they really working for? The agency's are really working for the investors, even though we pay them."
One member of the Securities and Exchange Commission has proposed improved regulation of the agencies, saying the firms are the only largely unregulated participants in the securities market.
Commissioner Richard Roberts has called for new rules and possible legislation to improve oversight of the agencies. "What started as a small, limited process, has grown," Mr. Roberts said. "There's ample competition, in terms of the price. That's not a problem."
Richard Breeden, chairman of the SEC, last month said he does not believe further regulation is necessary.
While many complain or question the current fee structures, no one interviewed wants a system so competitive that it affects market perceptions of the value of ratings.
"They are now in a position where they don't face the same competitive pressures as the industry does," said Mr. Katz, the financial adviser. "That's good because you don't want a situation where anyone is selling their ratings."
