RATING AGENCIES – Q&A
The Risk of Over-reliance on Ratings
Markus Krebsz, MSI
SII CPD Seminar, London – 2 July 2009
CONTENT
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Overview
Ratings
Application
Constructive criticism
Risks/Mitigants
Questions & close
2
OVERVIEW
QWIZDOM SURVEY
As part of this interactive workshop session
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•
•
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We asked 50 seminar attendees
to answer seven topical questions
and to submit their answers via each participants’
Qwizdom unit
The following pages
• Illustrate for each question
• the audience’s response
• Indicated by the Qwizdom symbol:
4
QUESTION 1:
Do you use Rating agencies and if so, how?
(A) I do not use them
(B) Once a day
or more
(C) Once a week
or more
A
24%
D
44%
(D) I do, but only infrequently
C
16%
B
16%
5
QUESTION 2:
How many (Credit) rating agencies exist globally?
(A) 3 to 5
(B) 6 to 15
A
10%
(C) 16 to 30
B
13%
D
52%
(D) More than 30
C
25%
6
1) A.M. Best Company, Inc.
2) Agusto & Co. Ltd.
3) Ahbor Rating
4) Apoyo & Asociados Internacionales S.A.C.
5) Bank Watch Ratings S.A.
6) BRC Investor Services S.A.
7) Calificadora de Riesgo, PCA
8) Capital Intelligence, Ltd.
9) Caribbean Information & Credit Rating Services Ltd. (CariCRIS)
10) Central European Rating Agency (CERA)
11) Chengxin International Credit Rating Co., Ltd.
12) China Lianhe Credit Rating, Co. Ltd.
13) Clasificadora de Riesgo Humphreys, Ltda.
14) Class y Asociados S.A. Clasificadora de Riesgo
15) CMC International, Ltd.
16) Companhia Portuguesa de Rating, SA (CPR)
17) Credit Analysis & Research Ltd (CARE)
18) Credit Rating Agency of Bangladesh, Ltd. (CRAB)
19) Credit Rating Information and Services, Ltd. (CRISL)
20) CRISIL, Ltd.
21) Dagong Global Credit Rating Co., Ltd.
22) Dominion Bond Rating Service (DBRS)
23) Duff & Phelps de Colombia, S.A., S.C.V
24) Ecuability, SA
25) Egan-Jones Rating Company
26) Equilibrium Clasificadora de Riesgo
27) European Rating Agency (ERA)
28) Feller Rate Clasificadora de Riesgo
29) Fitch Ratings, Ltd.
30) Global Credit Rating Co.
31) Interfax Rating Agency (IRA)
32) Investment Information and Credit Rating Agency (ICRA)
Source: www.defaultrisk.com
33) Islamic International Rating Agency, B.S.C. (IIRA)
34) Japan Credit Rating Agency, Ltd. (JCR)
35) JCR-VIS Credit Rating Co. Ltd.
36) Korea Investors Service, Inc. (KIS)
37) Korea Ratings Corporation
38) Lanka Rating Agency, Ltd. (LRA)
39) Malaysian Rating Corporation Berhad (MARC)
40) Mikuni & Co., Ltd.
41) Moody's Investors Service
42) National Information & Credit Evaluation, Inc. (NICE)
43) ONICRA Credit Rating Agency of India, Ltd.
44) P.T. Kasnic Credit Rating Indonesia -- Indonesia
45) P.T. PEFINDO Credit Rating Indonesia
46) Pacific Credit Rating (PCR)
47) Pakistan Credit Rating Agency, Ltd. (PACRA)
48) Philippine Rating Services, Corp. (PhilRatings)
49) RAM Rating Services Berhad (RAM)
50) Rapid Ratings International, Inc.
51) Rating and Investment Information, Inc. (R&I)
52) Rus Ratings
53) Seoul Credit Rating & Information, Inc.
54) Shanghai Credit Information Services Co., Ltd.
55) Shanghai Far East Credit Rating Co., Ltd.
56) Slovak Rating Agency, a.s. (SRA)
57) SME Rating Agency of India Limited (SMERA)
58) Sociedad Calificadora de Riesgo Centroamericana, S.A. (SCRiesgo)
59) Standard and Poors (S&P)
60) Taiwan Ratings, Corp. (TCR)
61) Thai Rating and Information Services Co., Ltd. (TRIS)
62) TheStreet.com Ratings, Inc.
63) Türk KrediRating (TCRating)
64) Veribanc, Inc.
7
QUESTION 3:
AAA (Fitch) = AAA (S&P) = Aaa (Moody’s)?
YES
32%
NO
68%
8
RATING PRINCIPLES
Fitch Ratings, Standard & Poor’s:
Probability of default (PD) = First dollar of loss
What is the ultimate default risk?
Moody’s:
Expected loss (EL) = [(PD) X (LGD)]
What is the amount of net loss suffered?
9
Y
QUESTION 4:
D (Fitch) = D (S&P) = D (Moody’s)?
YES
47%
NO
53%
10
RATINGS MAPPING TABLE
Fitch Ratings
Investment Grade
Long-term rating
Short-term rating
AAA
AA+
F1+
Long-term rating
Standard & Poors
Short-term rating
Long-term rating
Aaa
AAA
Aa1
AA+
Short-term rating
Mapped
internal
r a t i n g
iAAA
iAA+
A-1+
AA
Aa2
AA-
P1
AA
iAA
Aa3
AA-
iAA-
A1
A+
A-1
iA+
A
A-1 or A-2
iA
F1+ or F1
A+
A
F1
A2
A-
F1 or F2
A3
P-1 or P-2
AP-2
iAA-2
BBB+
F2
Baa1
BBB
F2 or F3
Baa2
P-2 or P-3
BBB
A-2 or A-3
iBBB
BBB-
F3
Baa3
P-3
BBB-
A-3
iBBB-
BB+
BB
Speculative Grade
Moody’s
B
BB-
BBB+
Ba1
BB+
Ba2
BB
Ba3
BB-
iBBB+
iBB+
iBB
B
Ranges within
B-1, B-2 and B-3
iBB-
B+
B1
B+
B
B2
B
iB
B-
B3
B-
iB-
Caa1
CCC+
iCCC+
CCC
Caa2
CCC
iCCC
CCC-
Caa3
CCC-
CC
Ca
CC
iCC
C
C
C
iC
CCC+
Not Prime
iB+
C
DDD, DD, D
D
Source: Bloomberg, Fitch, Moody’s and S&P
Moody’s: D
D
C
D
iCCC-
iD
11
QUESTION 5:
SF Bond 1 rated AAA (Fitch/ S&P/ Moody’s)
= SF Bond 2 rated AAA (Fitch/ S&P/ Moody’s)?
YES
13%
NO
87%
12
SUPER-SENIOR RATINGS
Structure 1
Tranche 1:
Tranche 2:
Tranche 3:
Tranche 4:
Tranche 5:
Tranche 6:
First Loss piece:
Structure 2
AAA
AA+
A
BBBBB
B+
NR
Tranche 1:
Tranche 2:
Tranche 3:
Tranche 4:
Tranche 5:
Tranche 6:
Tranche 7:
Tranche 8
First Loss piece:
AAA AA
AAA A
AAA
AA+
A
BBBBB
B+
NR
13
RATINGS
QUESTION 6:
How would you define ‘rating’?
(A) Opinion
(B) Benchmark
measure
for PD
AAA
(C) Benchmark
measure
for LGD D
A
25%
41%
C
3%
B
31%
(D) View not necessarily based on facts or knowledge
15
RATING DEFINITION
• An opinion… *
[Financial journalists]
• …on the relative ability…
• …of an entity to meet financial commitments.
*
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Ratings are benchmark measures of…
• Probability of default (PD)
• Expectations of Loss given default (LGD)
16
RATINGS…
…can capture:
…do NOT capture:
• Credit risk
Market risk Liquidity risk Operational risk Basis risk (IR risk) …and are “hard-wired”…
• by Basel II
• into banks’ credit rating models
• Investment guidelines and Asset management mandates
17
STATISTICAL: Probability of Default
30%
1-year PD
25%
20%
Moodys
15%
S&P
10%
Fitch
5%
80%
CCC/C
B-
B
B+
BBBB
BB
BB+
BBBBBB
BBB
BBB+
A-
A
A+
AAAA
AA
AA+
AAA
0%
10-year PD
70%
60%
50%
40%
Moodys
30%
S&P
20%
Fitch
10%
Source: Fitch Ratings
CCC/C
B-
B
B+
BB-
BB
BB+
BBB-
BBB
BBB+
A-
A
A+
AA-
AA
AA+
AAA
0%
18
RATINGS SCOPE
• Public
• Private
• Credit assessment
• Market-Implied ratings
(CDS, Equity, Spread, Price etc.)
19
RATING ACTIONS
Rating
DEAL STAGE
• Preliminary
• Final
• Paid in Full (PIF) /
Redemption
INDICATORS
• Upgrade, Downgrade
• Affirmation / Confirmation
• Withdrawn
Suffix
RATING WATCH
• Positive
• Negative
• Evolving / Uncertain
OUTLOOK
• Positive
• Negative
• Stable
20
APPLICATION
RATINGS are used by …
Banks, Other Financial Institutions, Originators & Issuers,
Investors, Financial Regulators, Other Rating agencies, etc. …
in order to …
•
•
•
•
Outsource analysis
Determine required economic and regulatory capital charges
Manage individual credit & portfolio risks
Feature as input into Structured Finance models (CDO2 etc.)
22
CONSTRUCTIVE CRITICISM
FAILURES
AIG, Bear Stearns, Bradford & Bingley, Enron, Icelandic banks,
Lehman Bros., Monolines, Northern Rock, Parmalat, etc.
In their own words...
Fitch: “… did not foresee the magnitude of the decline…or the
dramatic shift in borrower behavior…”
Moody’s: “We did not . . . anticipate the magnitude and speed
of the deterioration in mortgage quality or the suddenness of
the transition to restrictive lending.”
S&P: “it is now clear that a number of assumptions used in
preparing ratings on mortgage-backed securities issued
between 2005 and mid-2007 did not work.”
Source: US Government Oversight and Reform Committee, Oct 2008
24
CRITICISM
•
•
•
•
•
•
•
•
Business model: Too slow to react
Assumptions, methodologies & models
Conflict of interest (“issuer-pays” model)
Limited capture
Split ratings
Notching
Implied ratings & internal competition
etc.
25
THE RISKS OF OVER-RELIANCE
- AND SUITABLE MITIGANTS
TIMELY ACTIONS and DEFERRAL
Rating process:
Timeliness of Rating changes
Rating scope vs. time:
Bond maturity profile
• Process stages to reach
rating decisions
• Detection of bond- vs.
asset class-specific
and/or systemic issues
• Legal final vs. expected final
maturity
• Life-time ratings (40+ years)
• Timely payment of interest
& ultimate payment of
principal
27
TIMELAG of RATING ACTIONS
Number of Global SF Bond Downgrades
by CRA
190,000
180,000
170,000
176,046
160,000
TOTAL
150,000
S&P
Moody's
Fitch
140,000
130,000
120,000
110,000
111,605
100,000
90,000
80,000
70,000
68,372
60,000
50,000
40,000
49,594
50,968
1Q08
2Q08
47,510
30,000
30,749
20,000
10,000
7,992
1,166
2,042
1Q07
2Q07
0
3Q07
4Q07
3Q08
4Q08
1Q09
2Q09
(Since January 2007 - Source: Bloomberg)
28
Regional problem GLOBAL IMPACT
Number of Global SF Bond Downgrades
by Region
190,000
180,000
170,000
175,208
160,000
TOTAL
150,000
Europe
US
140,000
130,000
120,000
110,000
111,239
100,000
90,000
80,000
70,000
68,073
60,000
50,000
40,000
49,160
50,676
1Q08
2Q08
47,284
30,000
30,597
20,000
10,000
7,981
1,161
2,035
1Q07
2Q07
0
3Q07
4Q07
3Q08
4Q08
1Q09
2Q09
(Since January 2007 - Source: Bloomberg)
29
OPERATIONAL RISKS
• Changing methodologies and assumptions
• Timeliness of rating decisions
• Model risks
• Striking the right balance between non- and
over-regulation
30
RISK MITIGANTS
•
•
•
•
•
Understanding the meaning of ratings
Understanding instruments’ risks
Independent analysis
Internal ratings
Disputing rating decisions and methodologies
with the agencies – is it really worth it?
• Operational risk scenario: Awareness that
agencies CAN and DO get their ratings wrong
31
QUESTIONS & CLOSE
32
QUESTION 7:
Would you now give CRAs more or less credit ?
Less
Less
70%
More
More
30%
33
CONTACT
Markus Krebsz
+44 (0) 79 85 065 045
krebsz@web.de
markus.krebsz@4-most.co.uk
4most
Linen Hall
162-168 Regents Street
London, W1B 5TE
Tel. +44 (0) 207 038 3690
www.4-most.co.uk
ANNEX: Ratings & Probability of Default (PD)
1 year
Moodys
5 year
S&P
Fitch
Moodys
10 year
S&P
Fitch
Moodys
S&P
Fitch
Aaa
0.00%
AAA
0.00%
0.00%
Aaa
0.18%
AAA
0.10%
0.11%
Aaa
0.40%
AAA
0.45%
0.37%
Aa1
0.00%
AA+
0.00%
0.00%
Aa1
0.15%
AA+
0.16%
0.11%
Aa1
0.25%
AA+
0.34%
0.47%
Aa2
0.00%
AA
0.00%
0.00%
Aa2
0.28%
AA
0.15%
0.14%
Aa2
0.67%
AA
0.77%
0.68%
Aa3
0.00%
AA-
0.02%
0.01%
Aa3
0.18%
AA-
0.52%
0.25%
Aa3
0.33%
AA-
1.11%
0.91%
A1
0.00%
A+
0.05%
0.02%
A1
0.38%
A+
0.64%
0.41%
A1
0.84%
A+
1.68%
1.30%
A2
0.03%
A
0.04%
0.04%
A2
0.68%
A
0.42%
0.57%
A2
1.69%
A
1.80%
1.78%
A3
0.03%
A-
0.04%
0.04%
A3
0.65%
A-
0.86%
0.75%
A3
1.69%
A-
2.44%
1.91%
Baa1
0.17%
BBB+
0.22%
0.22%
Baa1
1.46%
BBB+
2.30%
1.82%
Baa1
2.31%
BBB+
4.65%
3.82%
Baa2
0.12%
BBB
0.28%
0.21%
Baa2
2.11%
BBB
2.17%
2.14%
Baa2
5.49%
BBB
5.27%
5.61%
Baa3
0.41%
BBB-
0.39%
0.42%
Baa3
3.60%
BBB-
4.94%
4.03%
Baa3
7.20%
BBB-
8.97%
8.23%
Ba1
0.66%
BB+
0.56%
0.63%
Ba1
6.76%
BB+
6.47%
6.19%
Ba1
12.38%
BB+
11.74% 12.25%
Ba2
0.62%
BB
0.95%
0.90%
Ba2
8.82%
BB
9.98%
8.37%
Ba2
14.66%
BB
17.34% 17.08%
Ba3
2.23%
BB-
1.76%
2.05%
Ba3
19.14%
BB-
15.03% 15.92%
Ba3
36.24%
BB-
24.97% 30.27%
B1
3.03%
B+
3.01%
3.10%
B1
25.27%
B+
20.86% 21.53%
B1
47.43%
B+
30.15% 38.18%
B2
5.93%
B
8.34%
7.24%
B2
31.24%
B
29.44% 27.84%
B2
44.48%
B
36.29% 41.06%
B3
10.77%
B-
12.15% 11.71%
B3
43.55%
B-
37.71% 39.23%
B3
62.32%
B-
45.05% 53.69%
Caa-C 22.24%
CCC/C 28.83% 25.54%
Caa-C 60.40%
CCC/C 50.85% 53.55%
Caa-C 78.81%
CCC/C 56.45% 65.07%
35