Rating Agencies - Q&A

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As presented on a SII CPD Seminar on 2 July 2009 in London - an updated version of the "Risk of Over-reliance on Ratings" presentation but with new slides and incorporated participants\' responses.

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Rating Agencies - Q&A

  1. 1. RATING AGENCIES – Q&A The Risk of Over-reliance on Ratings Markus Krebsz, MSI SII CPD Seminar, London – 2 July 2009
  2. 2. CONTENT • Overview • Ratings • Application • Constructive criticism • Risks/Mitigants • Questions & close 2
  3. 3. OVERVIEW
  4. 4. 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 The following pages • Illustrate for each question • the audience’s response • Indicated by the Qwizdom symbol: 4
  5. 5. QUESTION 1: Do you use Rating agencies and if so, how? (A) I do not use them (B) Once a day (C) Once a week or more or more A 24% D 44% B 16% C (D) I do, but only infrequently 16% 5
  6. 6. QUESTION 2: How many (Credit) rating agencies exist globally? (A) 3 to 5 A 10% (B) 6 to 15 (C) 16 to 30 B 13% D 52% C (D) More than 30 25% 6
  7. 7. 1) A.M. Best Company, Inc. 33) Islamic International Rating Agency, B.S.C. (IIRA) 2) Agusto & Co. Ltd. 34) Japan Credit Rating Agency, Ltd. (JCR) 3) Ahbor Rating 35) JCR-VIS Credit Rating Co. Ltd. 4) Apoyo & Asociados Internacionales S.A.C. 36) Korea Investors Service, Inc. (KIS) 5) Bank Watch Ratings S.A. 37) Korea Ratings Corporation 6) BRC Investor Services S.A. 38) Lanka Rating Agency, Ltd. (LRA) 7) Calificadora de Riesgo, PCA 39) Malaysian Rating Corporation Berhad (MARC) 8) Capital Intelligence, Ltd. 40) Mikuni & Co., Ltd. 9) Caribbean Information & Credit Rating Services Ltd. (CariCRIS) 41) Moody's Investors Service 10) Central European Rating Agency (CERA) 42) National Information & Credit Evaluation, Inc. (NICE) 11) Chengxin International Credit Rating Co., Ltd. 43) ONICRA Credit Rating Agency of India, Ltd. 12) China Lianhe Credit Rating, Co. Ltd. 44) P.T. Kasnic Credit Rating Indonesia -- Indonesia 13) Clasificadora de Riesgo Humphreys, Ltda. 45) P.T. PEFINDO Credit Rating Indonesia 14) Class y Asociados S.A. Clasificadora de Riesgo 46) Pacific Credit Rating (PCR) 15) CMC International, Ltd. 47) Pakistan Credit Rating Agency, Ltd. (PACRA) 16) Companhia Portuguesa de Rating, SA (CPR) 48) Philippine Rating Services, Corp. (PhilRatings) 17) Credit Analysis & Research Ltd (CARE) 49) RAM Rating Services Berhad (RAM) 18) Credit Rating Agency of Bangladesh, Ltd. (CRAB) 50) Rapid Ratings International, Inc. 19) Credit Rating Information and Services, Ltd. (CRISL) 51) Rating and Investment Information, Inc. (R&I) 20) CRISIL, Ltd. 52) Rus Ratings 21) Dagong Global Credit Rating Co., Ltd. 53) Seoul Credit Rating & Information, Inc. 22) Dominion Bond Rating Service (DBRS) 54) Shanghai Credit Information Services Co., Ltd. 23) Duff & Phelps de Colombia, S.A., S.C.V 55) Shanghai Far East Credit Rating Co., Ltd. 24) Ecuability, SA 56) Slovak Rating Agency, a.s. (SRA) 25) Egan-Jones Rating Company 57) SME Rating Agency of India Limited (SMERA) 26) Equilibrium Clasificadora de Riesgo 58) Sociedad Calificadora de Riesgo Centroamericana, S.A. (SCRiesgo) 27) European Rating Agency (ERA) 59) Standard and Poors (S&P) 28) Feller Rate Clasificadora de Riesgo 60) Taiwan Ratings, Corp. (TCR) 29) Fitch Ratings, Ltd. 61) Thai Rating and Information Services Co., Ltd. (TRIS) 30) Global Credit Rating Co. 62) TheStreet.com Ratings, Inc. 31) Interfax Rating Agency (IRA) 63) Türk KrediRating (TCRating) 32) Investment Information and Credit Rating Agency (ICRA) 64) Veribanc, Inc. Source: www.defaultrisk.com 7
  8. 8. QUESTION 3: AAA (Fitch) = AAA (S&P) = Aaa (Moody’s)? YES NO 32% 68% 8
  9. 9. 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
  10. 10. Y QUESTION 4: D (Fitch) = D (S&P) = D (Moody’s)? YES NO 47% 53% 10
  11. 11. RATINGS MAPPING TABLE Fitch Ratings Moody’s Standard & Poors Mapped Long-term rating Short-term rating Long-term rating Short-term rating Long-term rating Short-term rating internal r a t i n g Investment Grade AAA Aaa AAA iAAA AA+ F1+ Aa1 AA+ iAA+ A-1+ AA Aa2 P1 AA iAA AA- Aa3 AA- iAA- F1+ or F1 A+ A1 A+ A-1 iA+ A F1 A2 P-1 or P-2 A A-1 or A-2 iA A- F1 or F2 A3 A- iA- P-2 A-2 BBB+ F2 Baa1 BBB+ iBBB+ 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+ Ba1 BB+ iBB+ BB B Ba2 BB iBB Speculative Grade B BB- Ba3 BB- iBB- Ranges within B+ B1 B+ iB+ B-1, B-2 and B-3 B B2 B iB B- B3 Not Prime B- iB- CCC+ Caa1 CCC+ iCCC+ C CCC Caa2 CCC iCCC CCC- Caa3 CCC- C iCCC- CC Ca CC iCC C C C iC DDD, DD, D D Moody’s: D D D iD Source: Bloomberg, Fitch, Moody’s and S&P 11
  12. 12. QUESTION 5: SF Bond 1 rated AAA (Fitch/ S&P/ Moody’s) = SF Bond 2 rated AAA (Fitch/ S&P/ Moody’s)? YES NO 13% 87% 12
  13. 13. SUPER-SENIOR RATINGS Structure 1 Structure 2 Tranche 1: AAA Tranche 1: AAA AA Tranche 2: AA+ Tranche 2: AAA A Tranche 3: A Tranche 3: AAA Tranche 4: BBB- Tranche 4: AA+ Tranche 5: BB Tranche 5: A Tranche 6: B+ Tranche 6: BBB- First Loss piece: NR Tranche 7: BB Tranche 8 B+ First Loss piece: NR 13
  14. 14. RATINGS
  15. 15. QUESTION 6: How would you define ‘rating’? (A) Opinion (B) Benchmark (C) Benchmark measure measure A for PD AAA for LGD D 25% 41% B C 31% 3% (D) View not necessarily based on facts or knowledge 15
  16. 16. RATING DEFINITION • An opinion… * [Financial journalists] • …on the relative ability… • …of an entity to meet financial commitments. * ‹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) 16
  17. 17. 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
  18. 18. STATISTICAL: Probability of Default 30% 1-year PD 25% 20% 15% Moodys S&P 10% Fitch 5% 0% AA+ AA- A+ A- BB+ BB- BBB B A BBB+ BBB- B+ B- AAA AA BB CCC/C AA BB BBB 80% 10-year PD 70% 60% 50% 40% Moodys 30% S&P 20% Fitch 10% 0% AA+ AA- A+ A- BB+ BB- BBB B A BBB+ BBB- B+ B- AAA AA BB CCC/C Source: Fitch Ratings 18
  19. 19. RATINGS SCOPE • Public • Private • Credit assessment • Market-Implied ratings (CDS, Equity, Spread, Price etc.) 19
  20. 20. RATING ACTIONS Rating Suffix DEAL STAGE RATING WATCH • Preliminary • Positive • Final • Negative • Paid in Full (PIF) / • Evolving / Uncertain Redemption OUTLOOK INDICATORS • Positive • Upgrade, Downgrade • Negative • Affirmation / Confirmation • Stable • Withdrawn 20
  21. 21. APPLICATION
  22. 22. 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
  23. 23. CONSTRUCTIVE CRITICISM
  24. 24. 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
  25. 25. 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
  26. 26. THE RISKS OF OVER-RELIANCE - AND SUITABLE MITIGANTS
  27. 27. TIMELY ACTIONS and DEFERRAL Rating process: Rating scope vs. time: Timeliness of Rating changes Bond maturity profile • Process stages to reach • Legal final vs. expected final rating decisions maturity • Detection of bond- vs. • Life-time ratings (40+ years) asset class-specific • Timely payment of interest and/or systemic issues & ultimate payment of principal 27
  28. 28. TIMELAG of RATING ACTIONS Number of Global SF Bond Downgrades by CRA 190,000 180,000 170,000 176,046 160,000 150,000 TOTAL S&P Moody's Fitch 140,000 130,000 120,000 110,000 111,605 100,000 90,000 80,000 70,000 60,000 68,372 50,000 49,594 50,968 40,000 47,510 30,000 20,000 30,749 7,992 10,000 2,042 1,166 0 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 (Since January 2007 - Source: Bloomberg) 28
  29. 29. Regional problem GLOBAL IMPACT Number of Global SF Bond Downgrades by Region 190,000 180,000 170,000 175,208 160,000 150,000 TOTAL Europe US 140,000 130,000 120,000 110,000 111,239 100,000 90,000 80,000 70,000 60,000 68,073 50,000 40,000 49,160 50,676 47,284 30,000 20,000 30,597 7,981 10,000 2,035 1,161 0 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 (Since January 2007 - Source: Bloomberg) 29
  30. 30. OPERATIONAL RISKS • Changing methodologies and assumptions • Timeliness of rating decisions • Model risks • Striking the right balance between non- and over-regulation 30
  31. 31. 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
  32. 32. QUESTIONS & CLOSE 32
  33. 33. QUESTION 7: Would you now give CRAs more or less credit ? More Less Less More 70% 30% 33
  34. 34. 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
  35. 35. ANNEX: Ratings & Probability of Default (PD) 1 year 5 year 10 year 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% 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

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