Rating & Rating Agencies
Embed Size (px)
Transcript of Rating & Rating Agencies
Rating & Rating AgenciesRole & Risk of Investment What is a Credit Rating?An evaluation of the credit worthiness of a debtor
-The evaluation is made by a credit Rating Agency of the debtor's ability to pay back the debt and the likelihood of default.
- The debtor can be a business (company) or a government, but not individual consumers.
In contrast to Credit Rating Agencies, a company that issues credit scores for individual credit-worthiness is generally called a credit bureau''or ''consumer credit reporting agency.What is a Rating Agency?A Rating Agencyis a company that assigns ratings:
for issuers of certain types of debt obligations as well as the debt instruments themselves, for organizations,entities, local governments, which are assigned non-financialmissions or results.
The most renowned rating agencies are Credit Rating Agencies (CRA) which assign ratings to issuers. In most cases, the issuers of securities are:
Companies.Special purpose entities.National, state and local governments.Non-profit organizations.
Historical Brief (1 of 3)Mercantile credit agencies rated the ability of merchants to pay their debts, and consolidated these ratings in published guides.
First Agency established: In NY in 1841First published rating guide: 1857
Ratings began to be applied to securities related to the railroad bond market.Historical Brief (2 of 3)In 1913, the ratings publication by Moody's underwent two significant changes:
- It expanded its focus to include industrial firms and utilities- Began to use a letter-rating system
In late 1960s & 1970s, Ratings were extended to commercial paper and bank deposits.
Historical Brief (3 of 3)By 2009 the worldwide bond market (total debt outstanding) reached an estimated $82.2 trillion in 2009 dollars The need for ratingIn 1980s and 90s: A significant expansion of the global capital market due to:- The move away from bank loans toward cheaper and more long-term financing (tradable bonds and other fixed income securities)- The global move away from state intervention towards economic liberalism based on global capital marketsWhich are the main Rating Agencies?The main agencies that assign Credit Ratings are:
A.M. (USA) Baycorp Advantage (Australia) Dominion Bond Rating Service ( Canada) Fitch rating (USA) Japan Credit Rating Agency (Japan) Malaysian Rating Corporation (Malaysia) Moodys (USA) Standard & Poors (USA) Credit Pointe (U.S.) Pacific Credit Rating (Peru) Global Rating Intelligence ServicesRating Agency Malaysia (Malaysia) Egan-Jones Ratings Company (U.S.) Capital Intelligence Ltd (Cyprus) CRISIL (India) ICRA (India)
Big Threecredit rating agencies Middle-East and Africa Standard & Poor's, Moody's Investor Service, and Fitch Ratings 96% of all credit ratings
As of December 2012:
S&P 1.2 million outstanding ratings and 1,416 analysts and supervisorsMoody's 1 million outstanding ratings and 1,252 analysts and supervisorsFitch 350,000 outstanding ratingsThe Big Three AgenciesCredit rating agencies assess the relative credit risk of specific debt securities or structured finance instruments, borrowing entities (issuers of debt), and the creditworthiness of governments and their securities.
The use of credit ratings defines their function: "investment grade" ratings indicate relatively low to moderate credit risk, while those in the "speculative" or "non investment grade" categories signal a higher level of credit risk or that a default has already occurred.
Credit ratings express risk in relative rank order, which is to say they are ordinal measures of credit risk and are not predictive of a specific frequency of default or loss.
How it works?How it works?Initiation.Research.ApprovalDissemination.Periodic review (Evaluation of the Criteria).
In the course of the rating process, an analyst:
Gathers information sufficient to evaluate risk to investors who might own or buy a given security,
Develops a conclusion in committee on the appropriate rating,
Monitors the security on an ongoing basis to determine whether the rating should be changed.
To determine a bond's rating, a credit rating agency will analyze the accounts of the issuer and the legal agreements attached to the bond to produce what is effectively a forecast of the bond's chance of default, expected loss, or a similar metric.
The relative risks, i.e. the rating grades, are usually expressed through some variation of an alphabetical combination of lower and upper case letters, with either plus or minus signs or numbers added to further fine tune the rating
Ratings in bond marketRatings scalesPointsNotationImageCommentaries100-90AAAExcellent ImageExcellent Attractively89- 80AAGood ImageGood Attractively79-75AFair ImageFair Attractively74-73BBB72-71BB70B69-65CCPoor ImagePoor Attractively64-60CCCUnder 59DDDRankingNotationQuality#1AAASuperior; the best quality borrowers, reliable and stable (many of them governments)#2AAExcellent; quality borrowers, a bit higher risk than A#3AStrong; economic situation can affect finance#4BBBFair; more prone to changes in the economy, financial situation varies noticeably.#5BBQuestionable; currently vulnerable and dependent on favorable economic conditions to meet its commitments. #6BWeak; highly vulnerable, very speculative bonds. #7CCCVery weak; highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations.#8CCInsolvency probable/ Imminent; past due on interest; under regulatory supervision due to its financial situation.#9CInsolvent/ Default; has defaulted on obligations and Global believes that it will generally default on most or all obligations #10 DInsufficient Data#11 DDInsufficient operative experience#12 DDDRating procedure inapplicable
Rating ScalesMoody'sS&PFitchRating descriptionLong-termShort-termLong-termShort-termLong-termShort-termAAAP-1AAAA-1+AAAF1+PrimeAa1AA+AA+High gradeAa2AAAAAa3AA-AA-A1A+A-1A+F1Upper medium gradeA2AAA3P-2A-A-2A-F2Baa1BBB+BBB+Lower medium gradeBaa2P-3BBBA-3BBBF3Baa3BBB-BBB-Ba1Not primeBB+BBB+BNon-investment gradeBa2BBBBspeculativeBa3BB-BB-B1B+B+Highly speculativeB2BBB3B-B-Caa1CCC+CCCCCSubstantial risksCaa2CCCExtremely speculativeCaa3CCC-Default imminent with littleCaCCprospect for recoveryCCD/DDD/In default/DD/DThese securities are more complex and require an accurate diagnosis of repayment more difficult than with other debt ratings. This is because they are formed by pooling debt and structured by "slicing" the pool into multiple tranches", each with a different priority of payment.
Sovereign borrowers, including national governments, states, municipalitiesSovereign borrowers are the largest debt borrowers in many financial markets. Governments from emerging and developing markets may borrow from other governments and international organizations, such as the World Bank and the International Monetary Fund
Ratings in Structured Finance & in Sovereign DebtVariables of perception of the Attractively & Risk of Investment:Politics & Society Perception of Attractively Perception of Risk Freedom Status Corruption Public Ethics Elite Division Government efficiency Social Cohesion Judicial Independence Pressure Population Business Ethics Community antagonism Public Institutions Quality People drain Basic Education and Health of populations Insecurity Professional quality of labor Utilities Deficiency Quality of the labor market Inefficient government bureaucracy International Image of the Leader Youth unemployment rateEconomy & Business Perception of Attractively Perception of Risk Flow of investments Hard access to financing Natural resources endowment Un-initiative tax regulation Quality of private Foreign currency restrictions factor cost Uncontrolled Inflation Infrastructure Weak quality of financial services Macroeconomic framework Insufficient supply of infrastructure Development of market financial Unbalanced development Business Climate (Doing Business) Market size Global Technology capabilities Inadequate educated workforce Notoriety in the investors circles Poor work ethic in national labor forceCriticismThe CRAs ratings were characterized by critics as "catastrophically misleading and "provided little or no valueUntil the early 1970s, bond credit ratings agencies were paid by investors who wanted neutral information on the credit issuers and their particular offerings. Starting early 1970s, the "Big Three" ratings agencies began to receive payment for their work by the securities issuers for whom they issue those ratingsThis has led to charges that these ratings agencies can no longer always be impartial when issuing ratings for those securities issuers. Securities issuers have been accused of "shopping" for the best ratings from these three ratings agencies, in order to attract investorsInaccurate ratings and forecastsThe methodologies employed may be defective.
The rating agencies interest in pleasing the issuers of securities who are their paying customers and benefit from high ratings, creates a conflict with their interest in providing accurate ratings of securities for investors buying the securities.
The rating agencies may have been significantly understaffed during the subprime boom and thus unable to properly assess every debt instrument.
Agency analysts may be underpaid relative to similar positions with investment banks and Wall Street firms
The functional use of ratings as regulatory mechanisms may inflate their reputation for accuracy.Business ModelsMost agencies operate under one or a combination of business models: 1- the subscription model2- the issuer-pay