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Rating Agencies: The Risk Of Over-reliance On Ratings
 

Rating Agencies: The Risk Of Over-reliance On Ratings

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As presented to the Securities and Investment Institute\'s Risk Forum, London, 24 Feb. 2009.

As presented to the Securities and Investment Institute\'s Risk Forum, London, 24 Feb. 2009.

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    Rating Agencies: The Risk Of Over-reliance On Ratings Rating Agencies: The Risk Of Over-reliance On Ratings Presentation Transcript

    • RATING AGENCIES: The Risk of Over-reliance on Ratings An “Insider’s” View Markus Krebsz, MSI SII Risk Forum, London - 24 Feb 2009
    • CONTENT
      • Overview
      • Ratings
      • Application
      • Constructive criticism
      • Risks/Mitigants
      • Questions & close
    • OVERVIEW
    • QUESTION 1:
      • How many (Credit) rating agencies exist globally ?
        • 3 to 5
        • 6 to 15 16 to 30
        • More than 30
      • 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)
      • 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.
      Source: www.defaultrisk.com
    • QUESTION 2:
      • AAA (Fitch) = AAA (S&P) = Aaa (Moody’s) ?
    • 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?
    • QUESTION 3:
      • D (Fitch) = D (S&P) = D (Moody’s) ?
    • RATINGS MAPPING TABLE Moody’s: D Source: Bloomberg, Fitch, Moody’s and S&P
    • QUESTION 4:
      • SF Bond 1 rated AAA (Fitch/ S&P/ Moody’s)
      • = SF Bond 2 rated AAA (Fitch/ S&P/ Moody’s) ?
      • Structure 2
      SUPER-SENIOR RATINGS
      • Structure 1
      • Tranche 1: AAA
      • Tranche 2: AA+
      • Tranche 3: A
      • Tranche 4: BBB-
      • Tranche 5: BB
      • Tranche 6: B+
      • First Loss piece: NR
      • Tranche 1: AAA AA
      • Tranche 2: AAA A
      • Tranche 3: AAA
      • Tranche 4: AA+
      • Tranche 5: A
      • Tranche 6: BBB-
      • Tranche 7: BB
      • Tranche 8 B+
      • First Loss piece: NR
    • RATINGS
    • RATING DEFINITION
      • An opinion … * [Financial journalists]
      • … on the relative ability …
      • … of an entity to meet financial commitments .
      • *
      • … view not necessarily based on fact or knowledge
      • Ratings are benchmark measures of…
      • Probability of default (PD)
      • Expectations of Loss given default (LGD)
    • RATINGS…
      • … can capture:
      • Credit risk
      • by Basel II
      • into banks’ credit rating models
      • Investment guidelines and Asset management mandates
      • … do NOT capture:
      •  Market risk 
      •  Liquidity risk 
      •  Operational risk 
      •  Basis risk (IR risk) 
      … and are “hard-wired”…
    • STATISTICAL: Probability of Default Source: Fitch Ratings
    • RATINGS SCOPE
      • Public
      • Private
      • Credit assessment
      • Market-Implied ratings
      • (CDS, Equity, Spread, Price etc.)
    • RATING ACTIONS
      • Rating
      • DEAL STAGE
      • Preliminary
      • Final
      • P aid i n F ull (PIF) / Redemption
      • INDICATORS
      • Upgrade, Downgrade
      • Affirmation / Confirmation
      • Withdrawn
      • Suffix
      • RATING WATCH
      • Positive
      • Negative
      • Evolving / Uncertain
      • OUTLOOK
      • Positive
      • Negative
      • Stable
    • APPLICATION
    • RATINGS are used by …
      • Banks, Other Financial Institutions, Originators & Issuers,
      • Investors, Financial Regulators, Other Rating agencies, etc. …
      • Outsource analysis
      • Determine required economic and regulatory capital charges
      • Manage individual credit & portfolio risks
      • Feature as input into Structured Finance models (CDO 2 etc.)
      in order to …
    • CON STRUCTIVE 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
    • 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.
    • THE RISKS OF OVER-RELIANCE - AND SUITABLE MITIGANTS
    • TIMELY ACTIONS and DEFERRAL
      • Process stages to reach rating decisions
      • Detection of bond- vs. asset class-specific and/or systemic issues
      • Rating scope vs. time:
      • Bond maturity profile
      • Legal final vs. expected final maturity
      • Life-time ratings (40+ years)
      • Timely payment of interest & ultimate payment of principal
      Rating process: Timeliness of Rating changes
    • TIMELAG of RATING ACTIONS
    • OPERATIONAL RISKS
      • Changing methodologies and assumptions
      • Timeliness of rating decisions
      • Model risks
      • Striking the right balance between non - and over -regulation
    • 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
    • QUESTIONS & CLOSE
    • Q & A
      • For the Risk Forum
      • Has this presentation changed your view and perception of Ratings (= Opinion)?
      • Would you now give CRA more or less credit?
      • Do you think that CRAs should be properly regulated?
      • For the Presenter
      • Q1)…?
      • Q2)…?
      • Q3)…?
    • CONTACT
      • Markus Krebsz
      • +44 (0) 79 85 065 045
      • [email_address]
      • [email_address]
      • 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)