Credit Rating

Credit Rating Issues:

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What Does It Mean

What It Does Not Mean
Who Does It
How It is Done
Why Is It Undertaken
Who Pays For It
What Are Its Effects
How It Is Expressed
Credit Rating & Global Financial Crisis

Credit Rating

Credit Rating is a current opinion of an

obligors overall financial capacity (its
creditworthiness) to pay its financial
obligations.
This opinion focuses on the obligors
capacity and willingness to meet its financial
commitments as they come due.

Credit Rating

It does not apply to any specific financial

obligation, as it does not take into account
the nature of and provisions of the obligation,
its standing in bankruptcy or liquidation,
Long-Term Issuer Credit Ratings

Credit Rating

What it is not
A recommendation to buy or sell investments
A way of defining good or bad companies
An audit

Who Does It?

The global credit rating business is dominated by

three agencies:
Standard & Poor's
Moody's
Fitch
From the market share of the business point of
view, the biggest players are the first two agencies,
who controls around 90 percent of the business.

Credit Rating

Types of ratings
Issuer Credit Rating (ICR) or Counterparty
Credit Rating (CCR)
capacity & willingness to meet financial
commitments

Issue Rating
creditworthiness of a specific financial obligation

Bank Loan Rating

Rating Scale

AAA
AA
A
BBB
Investment Grade
------------------------------------------------------------------------BB Non-Investment Grade
B (Also Called Speculative Grade)
CCC
CC
C

Debt with a maturity of one-year or less, such

as commercial paper, are rated according to
Short-term rating scale.
They are given the scale of A-1+, A-1, A-2,
A-3, and B.

Information requirements
Organisation structure
Senior management background
5 years of detailed historical financial info
Detailed projections for 3 years including assumptions
List of bank lines available and recent usage
Financial documents, e.g. shareholder circular, issued over
the last 3 years
7. Detailed descriptive data relating to the operations of all
material divisions
8. Summary of corporate strategy together with perceptions
of risks and opportunities
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Credit Rating

Benefits of Credit Ratings to Issuers/

Counterparties
Supports disclosure & transparency
Provides independent peer comparisons
Enhances terms and conditions of
borrowings
Enhances access to new sources of
funds/markets

Credit Rating
Benefits of Ratings to Investors:

Benchmark for risk premium

Information and reference point
Simple global measure of credit risk
Assist in portfolio monitoring

Credit Rating

AAA
An obligor rated AAA has EXTREMELY
STRONG capacity to meet its financial
commitments.
AAA is the highest Issuer Credit Rating
assigned.

Credit Rating

AA
An obligor rated AA has VERY STRONG
capacity to meet its financial commitments.
It differs from the highest rated obligors only
in small degree.

Credit Rating

A
An obligor rated A has STRONG capacity
to meet its financial commitments but is
somewhat more susceptible to the adverse
effects of changes in circumstances and
economic conditions than obligors in higherrated categories.

Credit Rating

BBB
An obligor rated BBB has ADEQUATE
capacity to meet its financial commitments.
However, adverse economic conditions or
changing circumstances are more likely to
lead to a weakened capacity of the obligor to
meet its financial commitments.

Credit Rating
Obligors rated BB, B, CCC, and CC are

regarded as having significant speculative

characteristics.
BB indicates the least degree of speculation
and CC the highest.
While such obligors will likely have some
quality and protective characteristics, these may
be outweighed by large uncertain-ties or major
exposures to adverse conditions.

Credit Rating
BB
An obligor rated BB is LESS VULNERABLE

in the near term than other lower-rated obligors.

However, it faces major ongoing uncertainties
and exposure to adverse business, financial, or
economic conditions which could lead to the
obligors inadequate capacity to meet its
financial commitments.

Credit Rating
B
An obligor rated B is MORE VULNERABLE

than the obligors rated BB, but the obligor

currently has the capacity to meet its financial
commitments.
Adverse business, financial, or economic
conditions will likely impair the obligors
capacity or willingness to meet its financial
commitments.

Credit Rating

CCC
An obligor rated CCC is CURRENTLY
VUL-NERABLE, and is dependent upon
favorable business, financial, and economic
conditions to meet its financial commitments.

Credit Rating
CC
An obligor rated CC is CURRENTLY

HIGHLY-VULNERABLE.
Credit Rating is withdrawn upon the first
occurrence of any of the following:
1) a payment default on any financial
obligation, rated or unrated, other than a
financial obligation subject to a bona fide
commercial dispute;

Credit Rating

2) a voluntary bankruptcy filing by the issuer

or similar action; or,
3) in the case of banks, upon seizure of the
bank by a regulator, or, in the case of
insurance companies, upon placement of the
insurer under regulatory supervision due to
its financial condition.

Credit Rating

Plus (+) or minus (-) Ratings from AA to

CCC may be modified by the addition of a
plus or minus sign to show relative standing
within the major rating categories.

Credit Rating

Rating Outlook Definitions

Rating Outlook assesses the potential
direction of an issuers long-term debt rating
over the intermediate to longer term.
In determining a Rating Outlook,
consideration is given to any changes in the
economic and/or fundamental business
conditions.

Credit Rating
An Outlook is not necessarily a precursor of a
rating change or future CreditWatch action.
Positive indicates that ratings may be raised.
Negative means ratings may be lowered.
Stable indicates that ratings are not likely to
change.
Developing means ratings may be raised or
lowered.
N.M. means not meaningful.

Credit Rating

Short-Term Issuer Credit Ratings

A-1
A-2
A-3
B
C

Credit Rating
Average cumulative 5-year probability of
default
AAA
AA
A
BBB
BB
B
CCC

0.11 %
0.28 %
0.71 %
3.53 %
14.77 %
31.99 %
56.77 %

Credit Rating and Global Financial Crisis

On 13 Apr 2011, the US Senate
Investigations Subcommittee Released the
Levin-Coburn Report On the Financial
Crisis.
It has focused on the key causes of the
financial crisis

This Report focused on the Four aspects of

the crisis:
high-risk mortgage lending
regulatory inaction
inflated credit ratings that misled investors
the role played by investment banks

Inflated Credit Ratings.

The Report concludes that the most immediate
cause of the financial crisis was the July 2007
mass ratings downgrades by Moodys and
Standard & Poors that exposed the risky
nature of mortgage-related investments that,
just months before, the same firms had deemed
to be as safe as Treasury bills.

The result was a collapse in the value of

mortgage related securities that devastated
investors. Internal emails show that credit
rating agency personnel knew their ratings
would not hold and delayed imposing
tougher ratings criteria to massage the
numbers to preserve market share.

Even after they finally adjusted their risk

models to reflect the higher risk mortgages
being issued, the firms often failed to apply
the revised models to existing securities, and
helped investment banks rush risky
investments to market before tougher rating
criteria took effect.

 They also continued to pull in lucrative fees of up

to $135,000 to rate a mortgage backed security
and up to $750,000 to rate a collateralized debt
obligation (CDO) fees that might have been lost
if they angered issuers by providing lower ratings.
The mass rating downgrades they finally initiated
were not an effort to come clean, but were
necessitated by skyrocketing mortgage
delinquencies and securities plummeting in value.

In the end, over 90% of the AAA ratings

given to mortgage-backed securities in 2006
and 2007 were downgraded to junk status,
including 75 out of 75 AAA-rated Long
Beach securities issued in 2006.
When sound credit ratings conflicted with
collecting profitable fees, credit rating
agencies chose the fees.

Credit Rating

Basis for Economic Risk Analysis

Size and nature of economy and its
vulnerabilities
Growth prospects
Business cycle -- volatility
Structural problems -- inflation, etc.
Sensitivity of economy to foreign investment
Openness of economy

Credit Rating
Constraints on governments ability to pursue
appropriate
counter cyclical policies
Countrys political stability
Dynamics of savings and investment
Level and growth of domestic credit
Structure and strength of corporate clients
Financial strength of individual clients

Credit Rating

Leading Indicators of Financial System

Stress:
Trend in credit growth (private sector and
public enterprises)
Corporate and household indebtedness
Asset-price inflation
Net external funding of financial
institutions

Credit Rating
Industry Risk Analysis:
Number and relative size of banking institutions
Geographic or product restrictions
Size of bank loans in overall financial markets
Non-bank competitors
Depth of public capital market
Barriers to entry
Trends in industry

Credit Rating
Equity holdings or other interlocking
relationships
Political influence on bank lending decisions
Strength and efficiency of countrys legal system
Quality and transparency of accounting
Price sensitivity
Level of sophistication of customers
Relationship between banks and corporate clients

Credit Rating

Regulation and Deregulation:

State, national and international regulations

Trends in regulation
Regulatory structure -- level & quality
Regulatory structure -- degree of independence
Types of reporting by banks to regulators
Regulatory authority
Track record of regulators
Attitude of regulators toward bank support

Credit Rating
Management & Strategy:
Management Factors

Organizational structure
Controls/information systems
Performance vs. peers
Credibility

Succession planning
Realism, logic and risk
Implementation