credit rating agencies - what are they?
DESCRIPTION
A short presentation to explain what credit rating agencies are and what they do.TRANSCRIPT
RATING AGENCIES
THE POWER OF A LETTER
AN OVERVIEW
CRA
Ratings: what’s behind a
simple letter?
Are ratings all they do?
Are they really useful?
3 players. Are they alone?
Why?
WHY WERE CRAS BORN?
Rating Agencies
Investors need
Information: railways
Development of financial
markets
Help pricing issues: bonds
WHO ARE THE BIG THREE?
1913 John Fitch
Introduced letter rating
now the smallest
1890 Henry Poor
1906 Luther Blake
1941 merge
Largest, diversified
1909 John Moody
1970 stop rating Gov
First one
IS THE MARKET CONCENTRATED?
YES, YES IT IS!
BUT WHY?
Is it the SEC’s fault?
More efficient, less costly
Informal entry barriers
The two-rating norm
WHAT IS A RATING?
An opinion on credit risk
Forward looking and continually evolving
Not suggestions to buy or sell
Not an absolute measure of default probability
WHAT ARE THE CHARACTERISTICS OF A RATING?
A,B,C. What’s up with the Alphabeth?
Short and long term
Probability of Default
PIT vs TTC
Outlook and Watching
A, B, C
Categories of issuers and issues with
relatively higher levels of creditworthiness and
credit quality
Categories of issuers or issues with the
ability to repay but a likelihood of default or
failure
SHORT AND LONG TERM
LONG TERM: Original maturity of more than one year
SHORT TERM: Maturity of less than
one year and reduced scale
Relationship between long and short term
ratings.
PROBABILITY OF DEFAULT?
Precision for
autorities
Stability for
investors
PIT AND TTC
Point in time Current conditions
Through the cycle Survive economic cycle
OUTLOOK AND WATCHING
• Long term credit • Positive/negative • Stable/developing
Outlook
• Short term credit • In 3 circumstances • Within 90 days • Positive/negative • Stable/developing
Watching
They must be transparent
The criteria are public
Ratings models are proprietary
CRA encourage dialogue and confront
Committee, made up of a lead analyst, a managing director and junior analytical staff.
HOW ARE ISSUERS AND ISSUES RATED?
WHAT ARE THE BASIC MODELS?
Model driven
Quantitative data
Proprietary mathematical
formulas
Based on financial
statements
Analyst driven
Review of financial
information
Weight qualitative information (stategies)
Sector specific analysts
HOW IS AN ANALYST DRIVEN RATING COMPILED?
Rating an Issuer
Rating an Issue
Rating a structured finance instrument
HOW DO WE RATE AN ISSUER?
External support Higher rated guarantor/
parent Can have negative
impact
Creditworthiness before external support
Projecting cash flows
Economic environment
Balance sheet ratios
DIFFERENCES BETWEEN CORPORATE AND GOVERNMENT
Corporate Country risk
Industry
Competition
Diversification
Strategy
Regulatory environment
Management
Labor relations
Government Political stability
Growth prospects
Wealth, GDP
Demographics
Budget performance
Debt burden
War
Corruption
IN PARTICULAR FOR GOVERNMENTS: Category Fitch Moody’s S&P
Macro GDP Fiscal policy Competitiveness Balance of payments Economic growth
GDP, GDP per capita Scale of the economy
Economic growth Savings Behavior in economic cycles
Public finance Government’s assets Revenue to GDP Volatility of revenue
Ability to raise taxes, cut spending and sell assets
Revenue trends Size and health of non financial public enterprises
Debt Size and growth of public debt Maturity, interest Payments record
Level and structure of debt Interest payments
Composition and size of debt
Financial sector Foreign ownership quality
Sector strength Sector strength and effectiveness
Political Legimacy War Diplomatic relations
War Political consensus Transparency
Stability Geopolitical risk Corruption
Institutional Effectiveness of gov Trade openness Rule of law Human capital
Level of innovation Property rights Human capital Natural disasters
Public efficiency Competiveness private sector Labor flexibility
IN PARTICULAR FOR ENTERPRISES
Company Rating
• Accounting • Governance • Cash flow adequacy • Capital structure • Liquidity
Financial Risk
• Country risk • Industry characteristics • Market position • Profitability
Business Risk
Rating an issuer
Rating an issue
Rating a structured finance instrument
HOW DO WE RATE AN ISSUE?
Existence of credit enhancement
Letters of credit Guarantees Insurance
Relative seniority of the issue
In regard to others Priority of repayment
Issue’s characteristics
Term Conditions Legal structure
Creditworthiness of the issuer
At the start of the process Both for corporate and Gov.
Rating an issuer
Rating an issue
Rating a structured finance instrument
HOW TO RATE A STRUCTURED FINANCE INSTRUMENT
Not move forward with rating if there are not sufficient information
Analysts maintain they do not tell arrangers what to do
Analysts do not tell arrangers how to structure transactions
PROCEDURE TO RATE A STRUCTURED FINANCE INSTRUMENT
Operational risks
Servicer ability Servicer change
Payment structure
Sufficient cash flow Credit enhancement fees Effectiveness of insurance
Legal and regulator risks
Isolation Previous owners SPE exposure to bankruptcy
Credit quality of securitized assets
Loss estimation Benchmark comparison Historical data
WHO USES RATINGS?
Interest payments
Regulatory requirements
Banks
Interest payments
More attractive
Issuers
Rating triggers
Contracts
Risk assessment
Risk premium
Individual investors
Issue pricing
Sell securitized assets
Investment banks
Limitations
Bases for own analysis
Build benchmark indexes
Institutional investors
WHO PAYS FOR RATINGS? USER MODEL
User • No conflict of
interest
• Investors’
pressure • Limited
information access
WHO PAYS FOR RATINGS? ISSUER MODEL
Issuer • Free for investors • More info • Reputation • Analyst
compensation • Negotiator
• Financial ties • Ratings shopping • Unsolicited punitive
ratings
DEVELOPING NEW IDEAS…
Introduction of innovative lines of business
Gain more market share
Enrich the value
proposition
Diversify the activity
MOODY’S CASE
Moody’s Corporation
Moody’s Investors Services (MIS)
Credit ratings on a wide range of debt obligation and their
issuers
Moody’s Analytics (MA)
Research, Data and Analytics (RD&A)
Research on debt issuers, industry
studies, quantitative credit risk score
Risk Management Software (RMS)
Software solutions
Professional Services
Quantitative credit risk measures, credit
portfolio management solutions et al.
CORE BUSINESS
ALTERNATIVE AREA
MOODY’S REVENUE
MIS Revenue 1569 mil$
MA Revenue 712 mil$
Tot Revenue 2281 mil$
69%
31% MIS REVENUE
TOTAL MA REVENUE
Increasing Trend
RD&A 451 mil$
+6%
RMS 183 mil$
+6%
PS 77 mil$ +168%
MA 712 mil$ 13,5%
0
100
200
300
400
500
600
700
800
FY05 FY06 FY07 FY08 FY09 FY10 FY11
MA REVENUE
WHAT ARE THE REASONS FOR AN INCREASING TREND?
RD&A: greater demands for products supporting analysis
RMS: increased client usage of financial software
PS: Acquisition of companies providing other financial services
ARE CRAS ANY GOOD?
Advantages • Good institution get better
results (lower cost of debt) • Warn investors of risky
companies • Provide a Fair Risk-Return
Ratio • Wake up call for those in
need of improvement
Disadvantages • Subjective evaluation • Aren’t always accurate,
people trust less • Conflict of interest
BIBLIOGRAPHY
Butler, Cornaggia, Rating through the Relationship: Soft Information and Credit Rating, 2012
Claire Hill, Regulating the Rating Agencies IMF, Global Financial Stability Report, October 2010 IOSCO, Report on the Activity of Credit Rating Agencies, 2003 Moody’s, Annual Report, 2011 Moody’s, Annual Report, 2012 Federico Parmeggiani, La Funzione Economica e la Regolazione delle
Agenzie di Rating, 2011 Standard and Poor’s, General rating Criteria, 2012 Standard and Poor’s, Credit watch and Outlook, 2008 World Bank, Rating Agencies. No easy regulatory solutions, October 2009 Fitchratings.com Moneycrashers.com Moodys.com Standardandpoors.com/aboutcreditratings Wikipedia.com
TEAM MEMBERS:
Calamia Andrea Corriere S. Gianluca Martignoni Eleonora
Salituro Valeria Vanni Gianluca