The Role of Enterprise Risk Management
in S&P Ratings of Non-Financial Companies
Steve Dreyer
Managing Director
U.S. Utilities & Infrastructure Ratings
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Copyright © 2010 Standard & Poor’s Financial Services LLC, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.
Standard & Poor’s Ratings
History
1860:
Henry Varnum Poor Publishes “The History of the Railroads & Canals of the United States”
1906:
Luther Blake founds Standard Statistics Bureau to Provide Financial Info on c. 100 Cos.
1916:
Standard Statistics Begins to Assign Debt Ratings to Corporate Bonds
1941:
Poor’s Publishing and Standard Statistics Merge
1966:
The McGraw-Hill Companies, Inc. Acquires Standard & Poor’s
Coverage
 Ratings on Securities Valued At Over $30 Trillion
 Ratings on Debt In More Than 100 Countries
 Offices in 22 Countries
Scope
 Corporate (Industrials, Financial Institutions)
 Municipal and Other Public Entities
 Sovereigns
 Structured Transactions
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2.
Standard & Poor’s Role in the Capital Markets
Credit Ratings Provide Investors, Debt Issuers, Traders and
Counterparties…
– An Independent, Objective and Forward Looking
Opinion of Creditworthiness
– A Global Benchmark for Investors to Compare
Credit Risk Among Peers
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3.
Standard & Poor’s Credit Ratings Scale
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBBBB+
BB
BBB+
B
BCCC+
CCC
CCCCC
D
Extremely Strong
Very Strong
Strong
Investment Grade
Adequate
Vulnerable
More Vulnerable
Speculative Grade
Imminent Vulnerability
Highly Imminent Vulnerability
Default
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4.
70% of Ratings are Below Investment Grade
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBBBB+
BB
BBB+
B
BCCC+
CCC
CCCCC
D
2%
9%
20%
20%
42%
6%
1%
Counterparty Credit Ratings of U.S. Non-Financial Companies at Sep. 1, 2010
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5.
Default Frequency by Rating Category
Global Corporate Cumulative Average Default Rates by Rating, 1981-2009
(%)
(Time horizon, years)
Sources: Standard & Poor’s Global Fixed Income Research and Standard & Poor’s CreditPro ®
Copyright © Standard & Poor’s 2010
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6.
S&P Corporate Ratings Methodology
Financial
Business
Minimal
Modest
Intermediate
Significant
Aggressive
Highly
Leveraged
Excellent
AAA
AA
A
A-
BBB
--
Strong
AA
A
A-
BBB
BB
BB-
Satisfactory
A-
BBB+
BBB
BB+
BB-
B+
Fair
--
BBB-
BB+
BB
BB-
B
Weak
--
--
BB
BB-
B+
B-
Vulnerable
--
--
--
B+
B
CCC+
Our ratings combine the Business Risk Profile Score and Financial Risk Profile Score
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7.
S&P Corporate Ratings Methodology: Business Risk Profile
Financial
Business
Minimal
Business
Country Risk
Industry Risk
Competitive Position
Peer Comparisons
Profitability
Intermediate
Significant
Aggressive
AA
A
A-
BBB
--
Strong
Strong
AA
A
A-
BBB
BB
BB-
Satisfactory
Satisfactory
A-
BBB+
BBB
BB+
BB-
B+
Fair
Fair
--
BBB-
BB+
BB
BB-
B
Weak
Weak
--
--
BB
BB-
B+
B-
Vulnerable
Vulnerable
--
--
--
B+
B
CCC+
Business
Excellent
Strong
Satisfactory
Fair
Weak
Vulnerable
Components of the Business Risk Profile Score
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8.
Highly
Leveraged
Modest
AAA
Excellent
Excellent
S&P Corporate Ratings Methodology
Financial
Business
Minimal
Business
Country Risk
Industry Risk
Competitive Position
Peer Comparisons
Profitability
+
Intermediate
Significant
Aggressive
AA
A
A-
BBB
--
Strong
Strong
AA
A
A-
BBB
BB
BB-
Satisfactory
Satisfactory
A-
BBB+
BBB
BB+
BB-
B+
Fair
Fair
--
BBB-
BB+
BB
BB-
B
Weak
Weak
--
--
BB
BB-
B+
B-
Vulnerable
Vulnerable
--
--
--
B+
B
CCC+
Business
Excellent
Management:
Strategic Positioning
Operational Effectiveness
Strong
Satisfactory
Fair
Weak
Vulnerable
Components of the Business Risk Profile Score
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9.
Highly
Leveraged
Modest
AAA
Excellent
Excellent
S&P Corporate Ratings Methodology
Financial
Financial
Minimal
Modest
Intermed.
Business
Minimal Modest Intermediate
Cash Flow Adequacy
Liquidity / Short-Term Factors
Capital Structure / Asset Protection
Accounting / Information Risk
Aggressive
Aggressive
AA
A
A-
BBB
--
Strong
AA
A
A-
BBB
BB
BB-
Satisfactory
A-
BBB+
BBB
BB+
BB-
B+
Fair
--
BBB-
BB+
BB
BB-
B
Weak
--
--
BB
BB-
B+
B-
Vulnerable
--
--
--
B+
B
CCC+
Financial
Minimal
Modest
Intermed.
Significant
Aggressive
Components of the Financial Risk Profile Score.
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10.
Highly
Highly
Leveraged
Leveraged
Significant
Significant
AAA
Excellent
Highly
Leveraged
S&P Corporate Ratings Methodology
Financial
Financial
Minimal
Modest
Intermed.
Business
Minimal Modest Intermediate
Cash Flow Adequacy
Liquidity / Short-Term Factors
Capital Structure / Asset Protection
Accounting / Information Risk
Aggressive
Aggressive
AA
A
A-
BBB
--
Strong
AA
A
A-
BBB
BB
BB-
Satisfactory
A-
BBB+
BBB
BB+
BB-
B+
Fair
--
BBB-
BB+
BB
BB-
B
Weak
--
--
BB
BB-
B+
B-
Vulnerable
--
--
--
B+
B
CCC+
+
Management:
Financial Management
Governance & Financial Policies
Financial
Minimal
Modest
Intermed.
Significant
Significant
Aggressive
Components of the Financial Risk Profile Score.
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
11.
Highly
Highly
Leveraged
Leveraged
Significant
Significant
AAA
Excellent
Highly
Leveraged
S&P Corporate Ratings Methodology
Financial
Business
Minimal
Modest
Intermediate
Significant
Aggressive
Highly
Leveraged
Excellent
AAA
AA
A
A-
BBB
--
Strong
AA
A
A-
BBB
BB
BB-
Satisfactory
A-
BBB+
BBB
BB+
BB-
B+
Fair
--
BBB-
BB+
BB
BB-
B
Weak
--
--
BB
BB-
B+
B-
Vulnerable
--
--
--
B+
B
CCC+
Our ratings combine the Business Risk Profile Score and Financial Risk Profile Score
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
12.
S&P ERM Review for Non-Financial Corporations: Discussion Questions*
1.
What are the company’s top risks? How big are they? How often are they likely to occur?
How/when is this list updated?
2.
What is management doing about each of the top risks it faces?
3.
What size operating or cash loss has management and the board agreed is tolerable?
4.
Describe the staff responsible for risk management programs and their place in the
organization chart. How do you measure the success of risk management activities?
5.
How would a loss from a key risk impact incentive compensation of top management and on
planning/budgeting?
6.
Tell us about discussions about risk management that have taken place at the board level or
among top management when making strategic decisions.
7.
Give an example of how your company responded to a recent “surprise” in your industry and
describe whether the surprise affected your company and others differently.
* “Discussion Questions at Management Meetings”, on www.erm.standardandpoors.com
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13.
Managing Business Risks: Strategic Positioning
Scoring:
Positive
Credibility
vs. Company’s Stated Objectives, Capabilities & History
vs. Our Expectations
vs. Industry, Market & Economic Conditions
Neutral
vs. Strategy of Peers
vs. Company Culture
vs. Shareholder/Stakeholder Expectations
Negative
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14.
Managing Business Risks: Strategic Positioning
Scoring:
Positive
Incentives
Alignment of Compensation with Strategy
Consequences of Underperformance (Businesses & Individuals)
Neutral
Culture
Communication of Plans & Objectives
Record of Implementing Policies
Negative
Understanding Causes of Successes and Failures
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15.
Managing Business Risks: Strategic Positioning
Scoring:
Positive
Strategy Stability
Frequency and Nature of Changes
Unanticipated Acquisitions/Divestitures/Restructurings
Strategic Fit
Neutral
Diversification
Market Share Gains
Availability of Excess Cash, Cost Synergies
Valuation Considerations
Negative
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16.
Managing Business Risks: Operational Effectiveness
Scoring:
Positive
Execution
Expertise in Each Key Line of Business
Effectiveness of Audit & Control Systems
Performance vs. Expectations
Neutral
Organization Structure:
Effect on Efficiencies & Achievement of Strategies
Risk Awareness
Negative
Forecasting Ability
Identification of Influencing Factors
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17.
Managing Financial Risks: Financial Management
Scoring:
Positive
Sophistication of Financial Standards
Financial Risk Appetite: Beyond Unadjusted Leverage
Interdependencies of Risk
Performance vs. Expectations
Neutral
Risk / Reward Tradeoffs
Aggressiveness
Capital Levels & Structure
Negative
Liquidity Policy: Access to Financing
Allocation / Quality of Investments
Interaction with Board of Directors
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18.
Managing Financial Risks: Financial Management
Scoring:
Positive
Use of Risk Management Tools
Detail and Comprehensiveness of Guidelines
Asset / Liability Matching
Appropriate Use of Insurance, Hedging
Neutral
Accounting & Management Information
Aggressiveness of Accounting Choices
Degree of Adjustment Required
Transparency & Responsiveness, especially under stress
Negative
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19.
Managing Financial Risks: Governance & Financial Policies
Scoring:
Governance: Ownership Issues
Degree of Board Independence
Board Activism & Nature of Management Interaction
Governance: Management Issues
Neutral
Turnover, Concentration
Complexity of Organization Structure
Governance: Stakeholder Issues
Quality, Frequency, Consistency of Communications
Negative
Frequency & Level of Regulatory, Tax or Legal Conflict
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20.
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21.