The Credit Rating Agencies’ Side Businesses

Moody's (MCO -0.22%) and S&P Global (SPGI 0.31%) primarily make their money by rating the quality of corporate and government bonds, but they also have lucrative side businesses that generate additional income. These side businesses are extraordinarily profitable.

S&P Global generates more than $100 million of operating income each quarter just by licensing out its indexes, primarily the S&P 500 index, to ETFs and other index funds that use it. In this segment of Industry Focus: Financials, join host Gaby Lapera and Jordan Wathen as they discuss S&P Global's lucrative index fund side business.

A full transcript follows the video.

This video was recorded on June 26, 2017.

Gaby Lapera: The other thing to think about with these credit rating agencies is that they have access to all of the information. They have to, so that they can make these decisions. So, that actually translates into some of their side businesses, like Moody's Analytics or S&P market and commodities intelligence, which are subscription services which are sold to banks, insurance companies, The Motley Fool, sometimes.

Jordan Wathen: Right. So, once you collect all this information, as S&P, Moody's, and Fitch have done, they have all this information and another way to monetize it is to repackage it. S&P, this is a good one for a banking show, S&P recently bought out SNL Financial, which is basically the go-to bank information service provider. If you want to know what, say, Wells Fargo's non-performing loans looks like in 1982 and how that compared to other banks in the neighborhood, in California neighborhoods, they have that information. So, basically, these side businesses that they have, which aren't as important, for S&P, it's roughly half of their income, for Moody's it's only about 15% of their operating income. But these side businesses allow them to basically reuse information they've collected and resell it in different ways.

Lapera: Which is so smart. I have a coworker whose son is raising goats for a ritual that happens in Islam once a year. He's going to sell these goats to the local mosque. In the meantime, he's also hiring the goats out as lawn mowers, which is kind of the equivalent of the S&P and Moody's doing this with all the information they've collected. And congratulations to you, you're a very enterprising young man. The other thing that S&P does that I don't think Moody's does is the index funds.

Wathen: Right. Even if you don't know who Standard & Poor's is, you know S&P, and you probably just know it from the S&P 500, which is their premiere stock index. And because this has such a reputation, such a name as the large-cap index -- really there isn't a peer for it -- and because there's so much money willing to invest in the S&P 500 index, they've found it possible to license the S&P 500 name out to fund managers and charge a fee. It's usually 0.03% of assets under management, just to use the name and to use the index and the ETF name. So, every $100 that goes into an S&P 500 Index Fund, Standard & Poor's is collecting $0.03 on that, just for the rights to use its name. It's an amazing business. I would love to own that by itself, because it's truly incredible that they can basically collect royalties on index fund assets.

Lapera: Yeah, it's super cool to see all the ways that these companies are putting stuff together. And that's one of the reasons that CRAs is so interesting, is because they're using every part of the cow in order to make money. It's a very impressive business model.

Wathen: I wrote an article on this recently, it's really interesting, S&P really didn't realize, for a long time, just how valuable that brand is that it has, the S&P 500 brand. At one point, they actually gave Vanguard the license to use the S&P 500 name in one of its biggest funds for as little as $50,000 a year. It later turned out that they woefully underpriced that contract, and I think they've reworked it since. But this business of theirs is collecting over $100 million per quarter in pure operating income, just by skimming off the top of all these funds that are out there. It's truly incredible. If there's one business that I wish I could just own outright, it would be that, and I would just sit at home and check the mailbox every month for my next check. It's just an amazing business.