Download - Rating Agencies - Q&A
RATING AGENCIES – Q&AThe Risk of Over-reliance on Ratings The Risk of Over-reliance on Ratings
Markus Krebsz, MSI
SII CPD Seminar, London – 2 July 2009
CONTENT
• Overview
• Ratings
• Application
• Constructive criticism• Constructive criticism
• Risks/Mitigants
• Questions & close
2
OVERVIEW
QWIZDOM SURVEY
As part of this interactive workshop session
• We asked 50 seminar attendees• to answer seven topical questions• and to submit their answers via each participants’• Qwizdom unit• Qwizdom unit
The following pages
• Illustrate for each question• the audience’s response• Indicated by the Qwizdom symbol:
4
Do you use Rating agencies and if so, how?
(A) I do not use them
QUESTION 1:
(B) Once a day (C) Once a weekor more or more
(D) I do, but only infrequently
A
24%
B
16%C
16%
D
44%
5
How many (Credit) rating agencies exist globally?
(A) 3 to 5
QUESTION 2:
(B) 6 to 15 (C) 16 to 30
(D) More than 30
A
10%B
13%
C
25%
D
52%
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)
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)
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)
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.
7Source: www.defaultrisk.com
AAA (Fitch) = AAA (S&P) = Aaa (Moody’s)?
QUESTION 3:
NO
68%
8
YES
32%
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
D (Fitch) = D (S&P) = D (Moody’s)?
QUESTION 4:Y
NO
53%
10
YES
47%
RATINGS MAPPING TABLEF i t c h R a t i n g s
Long-term rating Short-term rating
AA-
AA
A
A+
BBB+
A-
BBB
AA+
AAA
F1+
F1
F1+ or F1
F1 or F2
F2 or F3
M o o d y ’ s
Long-term rating Short-term rating
Aa3
Aa2
A2
A1
Baa1
A3
Baa2
Aa1
Aaa
P1
P-1 or P-2
P-2
P-2 or P-3
S t a n d a r d & P o o r s
Long-term rating Short-term rating
AA-
AA
A
A+
BBB+
A-
BBB
AA+
AAA
A-1+
A-1 or A-2
A-1
A-2
A-2 or A-3Investment Grade
F2
M a p p e d
i n t e r n a l
r a t i n g
iAA-
iAA
iA
iA+
iBBB+
iA-
iBBB
iAA+
iAAA
11
B-
B
CCC
CCC+
CC
CCC-
DDD, DD, D
C
BB
BB+
B+
BB-
BBB- F3
B
C
B3
B2
Caa2
Caa1
Ca
Caa3
C
Ba2
Ba1
B1
Ba3
Baa3 P-3
Not Prime B-
B
CCC
CCC+
CC
CCC-
D
C
BB
BB+
B+
BB-
BBB- A-3
B
Ranges within
B-1, B-2 and B-3
C
Speculative Grade
iB-
iB
iCCC
iCCC+
iCC
iCCC-
iD
iC
iBB
iBB+
iB+
iBB-
iBBB-
D DMoody’s: D
Source: Bloomberg, Fitch, Moody’s and S&P
SF Bond 1 rated AAA (Fitch/ S&P/ Moody’s)
= SF Bond 2 rated AAA (Fitch/ S&P/ Moody’s)?
QUESTION 5:
NO
87%
12
YES
13%
Structure 2
SUPER-SENIOR RATINGS
Structure 1
Tranche 1: AAA
Tranche 2: AA+
Tranche 3: A
Tranche 1: AAA AA
Tranche 2: AAA A
Tranche 3: AAATranche 3: A
Tranche 4: BBB-
Tranche 5: BB
Tranche 6: B+
First Loss piece: NR
13
Tranche 3: AAA
Tranche 4: AA+
Tranche 5: A
Tranche 6: BBB-
Tranche 7: BB
Tranche 8 B+
First Loss piece: NR
RATINGS
How would you define ‘rating’?
(A) Opinion
(B) Benchmark (C) Benchmark
QUESTION 6:
measure measure
for PD for LGD
(D) View not necessarily based on facts or knowledge
A
25%
B
31%C
3%
D
41%
15
AAA
RATING DEFINITION
• An opinion… * [Financial journalists]
• …on the relative ability…
• …of an entity to meet financial commitments.
*
16
*
‹ä|xã ÇÉà ÇxvxáátÜ|Äç utáxw ÉÇ ytvà ÉÜ ~ÇÉãÄxwzx
Ratings are benchmark measures of…
• Probability of default (PD)
• Expectations of Loss given default (LGD)
RATINGS…
…can capture:
• Credit risk
…do NOT capture:
���� Market risk ����
���� Liquidity risk ����
• by Basel II
• into banks’ credit rating models
• Investment guidelines and Asset management mandates
���� Liquidity risk ����
���� Operational risk ����
���� Basis risk (IR risk) ����
17
…and are “hard-wired”…
STATISTICAL: Probability of Default
0%
5%
10%
15%
20%
25%
30%
AA
A
AA
+
AA
AA
-
A+ A A-
BB
B+
BB
B
BB
B-
BB
+
BB
BB
-
B+ B B-
CC
C/C
1-year PD
Moodys
S&P
Fitch
18
AA
A
AA
+
AA
AA
BB
B+
BB
B
BB
B
BB
+
BB
CC
C/C
0%
10%
20%
30%
40%
50%
60%
70%
80%
AA
A
AA
+
AA
AA
-
A+ A A-
BB
B+
BB
B
BB
B-
BB
+
BB
BB
-
B+ B B-
CC
C/C
10-year PD
Moodys
S&P
Fitch
Source: Fitch Ratings
RATINGS SCOPE
• Public
• Private
• Credit assessment
• Market-Implied ratings
(CDS, Equity, Spread, Price etc.)19
RATING ACTIONS
Rating
DEAL STAGE
• Preliminary
• Final
Suffix
RATING WATCH
• Positive
• Negative• Final
• Paid in Full (PIF) /
Redemption
INDICATORS
• Upgrade, Downgrade
• Affirmation / Confirmation
• Withdrawn
• 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. …
Outsource analysis
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
FAILURESAIG, 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…”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• Limited capture
• Split ratings
• Notching
• Implied ratings & internal competition
• etc.
25
THE RISKS OF OVER-RELIANCE - AND SUITABLE MITIGANTS
TIMELY ACTIONS and DEFERRAL
• Process stages to reach
rating decisions
• Detection of bond- vs.
Rating scope vs. time:
Bond maturity profile
• Legal final vs. expected final
maturity
• Life-time ratings (40+ years)
Rating process:
Timeliness of Rating changes
• Detection of bond- vs.
asset class-specific
and/or systemic issues
• Life-time ratings (40+ years)
• Timely payment of interest
& ultimate payment of
principal
27
TIMELAG of RATING ACTIONS
176,046
130,000
140,000
150,000
160,000
170,000
180,000
190,000
TOTAL S&P Moody's Fitch
Number of Global SF Bond Downgrades
by CRA
28
1,166 2,042
7,992
30,749
49,594 50,96847,510
68,372
111,605
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000
110,000
120,000
1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09(Since January 2007 - Source: Bloomberg)
Regional problem ���� GLOBAL IMPACT
175,208
120,000
130,000
140,000
150,000
160,000
170,000
180,000
190,000
TOTAL Europe US
Number of Global SF Bond Downgrades by Region
29
1,161 2,0357,981
30,597
49,160 50,67647,284
68,073
111,239
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000
110,000
120,000
1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09(Since January 2007 - Source: Bloomberg)
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• 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
Would you now give CRAs more or less credit ?
QUESTION 7:
More
Less
70%
More
30%
33
LessMore
CONTACT
Markus Krebsz+44 (0) 79 85 065 045
4mostLinen 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)
Moodys S&P Fitch Moodys 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%
1 year 5 year 10 year
35
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%