V SEC Examinations Find Shortcomings in Credit Rating

Agencies' Practices and Disclosure to Investors, ¬




V The SEC staff's examinations found that rating agencies

struggled significantly with the increase in the number
and complexity of subprime residential mortgage-
backed securities (RMBS) and collateralized debt
obligations (CDO) deals since 2002. The examinations
uncovered that none of the rating agencies examined
had specific written comprehensive procedures for
rating RMBS and CDOs. Furthermore, significant
aspects of the rating process were not always disclosed
or even documented by the firms, and conflicts of
interest were not always managed appropriately.
V an this unprecedented world credit crisis we have
heard very little from Moody·s and Standard & Poor·s
yet both share blame for the current market opacity.
V an the past weeks we have seen the largest transfer of
private risk to public risk in financial history. Yet the
agencies have said nothing. Fannie Mae, Freddie Mac,
Aa and Lehman bonds alone account for $1,800bn
nominal of agency-rated corporate debt.
V Sadly in the current crisis there is no first-mover
advantage for the agencies to call attention to the fact
they were operators in the current credit meltdown.
V But they cannot remain silent forever. To avoid
the heavy burden of a regulatory fate, the rating
agencies must take action soon.
V The world of independent credit opinion needs
more competitors for their own survival
outside the regulatory impulses of the
government.
V S&P and Moody·s and Fitch should issue an
advisory opinion discouraging risk managers
from depending solely on their opinions and
ratings as the foundations for risk model
inputs.
A lesson from the present crisis ² do not blindly
rely on the CRA.
lobal financial crisis has put cra in the limelight
as they failed to give adequate warning to
investors of the risk involved in MBS and other
structured products.
US sub-prime crisis ² cra were blamed for their
generous rating of dubious mortgage linked
instruments during boom.
V anherent conflict of interest
V Adverse Business Model
V Ratings are opinion and not guarantee.s
V Recently concluded 20 summit calls for
globally consistent standard on anternational
Organization of Securities Commission
(aOSCO) proposals to put appropriate
procedures in place
V 1.Standard & Poor,
V 2. Moody's anvestor Services and
V 3. Fitch Ratings
V All 3 are under regulatory scrutiny for their passive
role in the 2007 US residential mortgage backed
securities (RMBS) crisis.
V - Key role in the bankruptcy of California based
Orange County ² 1994. Orange County a very rich
municipality in California went bankrupt due to
speculation in derivatives. However CRA had given
good rating.
V - iving superior investment grade to Enron in 2001.
V - Role was reactive in Asian crisis rather than being
proactive.
V The Standard & Poor's rating scale is as
follows: AAA, AA, A, BBB, BB, B, CCC, CC, C,
D. Anything lower than a BBB rating is
considered a speculative or junk bond.
V The Moody's rating system is similar in concept
but the verb age is a little different. at is as
follows: AAA, Aa1, Aa2, Aa3, A1, A2, A3,
Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3,
Caa1, Caa2, Caa3, Ca, C.
V Country risk rankings
V Euromoney Country risk March 2008
V Least risky countries, Score out of 100
V Ratings are further broken down into
components including political risk, economic
risk.
V Euromoney's bi-annual country risk index
"Country risk survey´ monitors the political
and economic stability of 185 sovereign
countries. Results focus foremost on
economics, specifically sovereign default risk
and/or payment default risk for exporters
("trade credit" risk)
?
 

  


     

   
!"
# $
  %
    
& & !#
$
$ $ '
#  $
 ( )
  &
V CRaSaL, Credit Rating anformation services of andia LTD. From a
pioneering step taken in 1987, to playing an integral role in andia's
development milestones, CRaSaL has emerged as andia's leading Ratings,
Research, Risk and Policy Advisory company.

V CARE Credit Analysis & Research Ltd. (CARE), incorporated in April

1993, is a credit rating, information and advisory services company
promoted by andustrial Development Bank of andia (aDBa), Canara Bank,
Unit Trust of andia (UTa) and other leading banks and financial services
companies. an all CARE has 14 shareholders

V aCRA , anvestment Credit Rating Agency of andia Ltd (an Associate of

Moody's anvestors Service) was incorporated in 1991 as an independent
and professional company. aCRA is a leading provider of investment
information and credit rating services in andia. aCRA·s major
shareholders include Moody's anvestors Service and leading andian
financial institutions and banks.
V Onicra ² SSa and SME rating ² approved by the ovt of
andia and andian banks association. NSCa is its nodal
agency
V Rating 1A, 1B, 1C ² 5A, 5B ,5C( high to Poor)

V SME rating agency of andia (SMERA) (1995)

is a joint initiative by SaDBa, Dun & Bradstreet

anformation Services andia Private Limited (D&B), and
several leading banks in the country.
-- Objective is to enhance credit flow to credit-constrained
SME sector. at was first of its kind in the world.
--The agency would rate any individual or company
engaged in any field like manufacturing, trading,
business and commerce but not the non banking
finance corporations (NBFCs), chit funds and ¶nidhis·.
V CRaSaL·s association with Standard & Poor·s, a
division of The Mc raw-Hill Companies, dates
back to 1996 when both companies started
working together on rating methodologies and
joint projects. S&P is the world's foremost
provider of independent credit ratings, indices,
risk evaluation, investment research, data and
valuations. This partnership has now
culminated in Standard & Poor·s acquiring a
majority shareholding in CRaSaL.
V Ratings and Risk Assessment
V CRISIL Ratings
V CRaSaL Ratings is the only ratings agency in andia to operate on
the basis of sectoral specialisation. at reflects sharpness of analysis,
the responsiveness of the process and the large-scale
dissemination of opinion.
CRaSaL Ratings plays a leading role in the development of the
debt markets in andia.
The Rating Criteria & Product Development Centre, responsible
for policy research, new product development and ratings' quality
assurance, has developed new ratings methodologies for debt
instruments and innovative structures across sectors.

Standard & Poor's, the financial services business of The Mc raw-

Hill Companies, the world's foremost provider of independent
credit ratings, indices, risk evaluation, investment research, data
and valuations, enables Crisil to anticipate new market challenges
and introduce value-added ratings methodologies.
Crisil has partnered with Standard & Poor on several projects in
the US and East Asia and jointly promote business and services in
andia.
V CARE has been granted registration by SEBa
under the Securities & Exchange Board of andia
(Credit Rating Agencies) Regulations,1999.
V The rating coverage has extended beyond
industrial companies, to include public utilities,
financial institutions, infrastructure projects,
special purpose vehicles, state governments
and municipal bodies. CARE's clients include
some of the largest private sector
manufacturing and financial services
companies as well financial institutions of
andia. CARE is well equipped to rate all types
of debt
V To increase investor confidence and guide
them
V Facilitate decision making
V Measures probability of default to meet
obligations
V Strengths and weaknesses of the company
V Rated instrument enjoys higher confidence
V Provide information and guidance to
institutional and individual investors/creditors.
V Enhance the ability of borrowers/issuers to
access the money market and the capital market
for tapping a larger volume of resources from a
wider range of the investing public.
V Assist the regulators in promoting transparency
in the financial markets.
V Provide intermediaries with a tool to improve
efficiency in the funds raising process.
V CRA are not auditors

V Credit rating changes with time

V Judgment in andia is a mix of quantitative and

qualitative factors

V as it necessary to regulate CRA

V Solicited or Unsolicited ratings

V Regulating the Raters

V Credibility arises from objectivity of resource
allocation
V Rating agencies are not and should not assume
the role of regulators
V Continued growth and evolution of the credit
rating business would depend on the size and
the growth of the debt market.
V CR involves subjective judgment with objective
analysis
V Rating shopping is a cause of concern
V Lack of transparency on the part of CRA
V an most country·s CRA are not regulated
V Credibility arises from objectivity of resource
allocation
V Fuzziness of data
V Readiness/ Reluctance of the company in
disclosing information
V Proper control systems are not in place
V Credibility of the agencies carrying out the
rating
V andustry is still young
V Fuzziness of data
V  = 1.2 X1 + 1.4 X2 + 3.3 X3 +0.6 X4 + 1.0 X5
V Where
V X1 = W.K. / TA
V X2 = RE / TA
V X3 = EBaT / TA
V X4 = MV of equity / BV of debt
V X5 = Sales / TA
V  is less than 1.81
V  is greater than 2.99
V Conclusions
V Still Young
V Foreign CRA entering andia, quality will
improve
V No credit rating association
V Attempt to develop core competencies
V Do rating agencies conduct a primary audit?

V as it mandatory for the rating agencies to follow

international norms?

V Can the rating agencies demand information as

a matter of right?
V as an appraisal in continuum required?