COMMUNICATING EFFECTIVELY WITH RATING AGENCIES 1. Ratings g defined 2. Communicating with Rating Agencies
! Communicating with Rating Agencies By Thomas Missong
This presentation is a short summary of the presentation held during the World Forum for Communication Top-Managers p g in Davos. Note that this presentation is of general character and does not relate specifically to one rating agency. You may use this presentation for personal use.
DAVOS – February 2010
World Forum for Communication Top-Managers
1- RATINGS DEFINED
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers
Investm ment Grade
RATING IS …
Repayment Capacity Extremly strong Very strong
Adequate
Adequate but vulnerable
High Yield H
Vulnerable u e ab e
Currently vulnerable
Highly vulnerable
Fitch & S&P AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BCCC+ CCC CCC-
Communicating with Rating Agencies By Thomas Missong
Moody's Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 a Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3
• •
… a general evaluation of creditworthiness.
•
… is an opinion on the ability and willingness to pay back the debt on time and in full.
•
… a forward-looking f d l ki th through-the-cycle h th l opinion i i / prediction about relative creditworthiness (Moody’s)
•
„Obligations Obligations carrying the same rating are not claimed to be of absolutely equal credit quality. In a broad sense, they are alike in position, but since there are a limited number of rating classes used in grading thousands of bonds the symbols cannot reflect the same shadings of bonds, risk which actually exist“ (Moody‘s)
… a general measure for probability and severity of default.
DAVOS – February 2010
World Forum for Communication Top-Managers
PURPOSE AND ADVANTAGES OF A RATING
Rating Agency
Issuer
Bank
Issuer
Credit institutions
Pension Funds
Insurance Reinsurance
UCITS
•
For investors: - Independent credit risk evaluation as benchmark - Risk premium evaluation g from registered g rating g agencies g may y be used of capital p requirement q p purposes p - From December 7th, 2010 ratings
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For Issuer: extension of the number of potential investors. - Through ratings, borrowers can achieve higher deal volumes, longer maturities and lower overall costs or y Ratings g are required q by y many y international institutional investors - depending p g on enhance the financial flexibility. your rating, your will address different types of investors. - Name recognition, which attracts direct foreign investment is achieved through ratings. - Ratings are also used in Supply chain decisions (eg Automotive industry)
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers
DIFFERENT TYPES OF RATINGS AND THEIR MEANINGS A+ / Stable / F1 Long Term Rating (“LT”): ( LT ): Time horizont up to 3 years Global Scale AAA AA+ AA AAA+ A A ABBB+ BBB BBB BBBBB+ BB BBB+ B BCCC+ CCC CCCCC+
Outlook: How will the rating evolve in the next 18 months (positive, stable, negative, Credit Watch)
ShortTerm Rating (“ST”): ( ST ): Time horizont up to 1 years
National Scale
Foreign Currency and National currency: Given that transfer and exchange risks do not exist for national currencies, National currency ratings tend to be higher than the Foreign Currency ratings. ratings The international benchmark is the Foreign Currency long term rating
AAA AA A BBB BB B C
Global versus National scales:
Other Financial ratings:
In countries having a low sovereign rating, rating agencies migth provide national ratings in order to better distinguish between the credit qualities.
• •
Solicited / Unsolicited rating
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Corporate Family Rating
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
Financial Strength rating / Stand alone a o e rating, at g, Support Suppo t Rating at g Issuer versus Issue Rating
World Forum for Communication Top-Managers
RATING PROCESS ISSUER - RATING AGENCY
Analytical team assigned
Basic research conducted Development of Story DevelopCredit of specific
questions Due Diligence
Packaging of Rating Handbook
Meeting with Management Receive rating handbook
Rating committee meeting and rating decision
Publish rating and rating commentary
Surveillance
The rating process depends from Agnecy to agency. The process here is illustrative and shows only the main steps:
• • • • •
Analytical y team consists of a Lead Analyst y and a Secondary y Analyst y Treatment of all information available including Rating Handbook Meeting between Rating Agency and Management, on-site visits Rating assignment in the rating committee Publication of rating (you may ask for a confidential rating)
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers
Fields of Analysis
Local/ national issues
Industry Methods
Financial Strength
Segment Analysis
Financial Flexibility
Financial Projections
Rating Committee
Improving information and analysis base
Peer Analysis
Rating Agencies distinguish between: -Quantitative Quantitative and qualitative factors -Business Risk and Financial Risk Note: The elements shown here are illustrative and depend on each agencies methodologies and terminology!
Communicating with Rating Agencies By Thomas Missong
Dependance
Corporate Governance
Rating Methodologies need d to t be b published bli h d by b the agencies.
DAVOS – February 2010
Strategy
Fields of analysis requiring Meeting with Management
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INFORMATION PACKAGE
Issuer
•
Rating Agency
Credit quality
Standard documents
Current profile
¾ 3 yyears of historical, audited annual financial statements
¾ Latest interim/quarterly statements ¾ Recent offering documents / information memorandums
¾ Selected research reports, if available ¾ Recent press releases ¾ Any relevant public presentation made to the financial and business community
¾ Sample marketing materials and brochures
Communicating with Rating Agencies By Thomas Missong
time
As Ratings are forward looking, a comprehensive management presentation ((“Rating Rating Handbook Handbook”)) needs to be prepared: ¾ strategy, market and competitive environments, review of operations, segmental results and projections, ¾ financial policies, policies review of financial performance with projections (3 years at least) and key underlying assumptions, ¾ background, history, ownership, governance, corporate and management structure / profile, profile
DAVOS – February 2010
World Forum for Communication Top-Managers
COMMUNICATING WITH AGENCIES
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers
FLOW OF INFORMATION
Rating Agency 1 1 Issuer
2 2
Bank
Issuer
3
Investors
2
Relationship unrated issuer – banks:
1. 2.
The issuer provides information to the bank the bank grants the financing and sets the terms based on an internal rating
Relationship rated issuer – rating agency – investors:
1. 1 2.
Issuer provides information to the rating agency
3.
Investors may use the rating agency in the decision to provide financing to the issuer
Rating agency decides on ratings and provides report to Issuer and public
Please note
• •
Communicating with Rating Agencies By Thomas Missong
Information provided to rating agency is confidential Information requirement is high
DAVOS – February 2010
World Forum for Communication Top-Managers
SOURCES OF INFORMATION Own sources
External sources
Issuer
•Industry reports •Research R h papers •National statistics •Newspaper
Peer Group Issuer Issuer
Methodologies Rating Agency
Issuer
Investors
In order to have a full picture on the Issuer, Rating Agencies will not only rely on information from the Issuer, but will use own sources of information as well as external sources The new EU Regulation foresees that the rating agencies need to disclose the information used in the context of the rating assignment. Rating Agencies should also evaluate the quality of information received as well as their reliability. Providing information from external sources to the Rating Agency might be viewed positively.
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers
SOURCES OF NOISE Terminology:
Issuer
•
Issuer
•
•
Peer Group
financial ratios and key indicators are not always properly defined. defined Some agencies adapt the financial figures received according to their own methodologies – ratios might therefore substantially deviate!
Issuer
Rating Methodologies are applied for assessing an entity. None the less, the Agency might consider additional factors or change the weighting assigned. Next to the main sector methodology, Agencies might apply further methodologies.
Methodologies
Iss er Issuer
Although the Rating scales are widely used, their terminology is not uniform. Difference relate to: - Probability of default - Time of reference of the ratings - Loss given default / Recovery rates
Rating Agency Agenc employee
Rating committee
Intercultural issues S Semantic ti issues i
Intercultural issues: Understanding local circumstances and business model
Communicating with Rating Agencies By Thomas Missong
Issuer Employee Emplo ee
In order to achieve the optimal rating, you may envisage engaging a rating advisor. This might reduce the : 9The issuer gets a better in-sight into methods and peer-group information 9The rating agency receives the information according to their own standards
DAVOS – February 2010
World Forum for Communication Top-Managers
RATING AGENCIES AS OPINION LEADERS
Credit institutions
Pension Funds
Issuer
Ratings are an Opinion per definition Agencies treat the information and provide summaries and their views on the Issuer’s credit quality lit
UCITS
= All-in Cost
Article 4.1 on the „Use of Credit Ratings” of the Regulation on Credit rating agencies sates that financial institutions “may may use credit ratings for regulatory purposes only if they are issued by credit rating agencies (…) registered in accordance with this Regulation”
Interes st Rate e
Investors may be Opinion Followers:
Financial institutions tend to us external ratings if they are better than the internal ratings. The on-going revision of the Basel 2 framework tackles the so-called cliff-effect
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
+ M&U / Expenses + “Credit Credit Spread Spread” + Return in Capital
Reference Rate (Euribor, Libor )
Interest Rate
Insurance Reinsurance
• •
Marg gin
Rating Agency
Rating Agencies are Opinion Leaders for financial investors:
+ Liquidity Li idit Costs C t Maturity
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FACTORS AFFECTING THE COMMUNICATION
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Degree of complexity of an agency: - The bigger an agency gets, the less people you will know! - Number of methodologies
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Degree of transparency: - Although EU regulation requires Rating Agencies need to publish their rating methodologies
Identtifying Key Rating Factors:
Assessment and measurement of key Rating factors:
• Business Risk
•Q Qualitative & Quantitative Q
• Management Risk
• Historic & Projected
• Financial Risk
• Peer
Mapping of Key Factors to Rating Categories: • Historic (5y averages)
Weighting of Factors to derive indicative Rating
Other Factors: • Regional considerations
Rating Committee and decision on Rating
• Event risk..
• Projected
•
Moody‘s introduced so called „Mapping Methodologies“: - Can be used as a guide how to assign ratings as key rating factors by sector are identified and explained - The rating process is quantified as much as possible using Mapping grids, credit metrics and weigthing - Note: these new methodologies were impelemented only in the last couple of years and did not lead to any immediate rating changes. When using the methodology, have a carefull look onto the outlayers.
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Degree of openness and accessibility: y can you y clarifyy open p issues with the Agency? g y - How easy Rating agencies are a dynamic social system changing over time and adapting to new circumstances Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers
FACING A RATING ACTION
Sovereign specific reasons
• • •
The Long term Foreign Currency rating of an issuer is constrained by the rating of the Sovereign.
A change in the outlook of the rating is a clear signal from the agency:
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A downgrade of the sovereign leads directly to the downgrade of the issuer, an upgrade not necesarily.
It might take the rating action within a period of 18 months
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Note N t that th t Sovereign S i ratings ti ttend d tto be b more stable t bl than Corporate ratings.
In times of stress, a rating agency might take several ratings within a very short time frame frame.
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Rating agencies may use “credit Watch” or “evolving”, in this case it is hard to guess the rating action.
Industry specific reasons
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Revision of methodology (Request for Comment)
Relationship between business, financial, and distress risks
Macro-economic environment
Volatility/Risk
Issuer specific reasons:
• • •
Change in strategy / management Financial performance deviating from agencies expectation Material change in ownership, government related issuer’s issuer s approach no longer applicable
Communicating with Rating Agencies By Thomas Missong
Business risk
Financial cushion (Determined by financial risk profile and metrics) Time/Cycle Distress level
DAVOS – February 2010
World Forum for Communication Top-Managers
RATING AGENCIES ACT
80
Risk Premium (“Credit Spread”) 1 Year
5 Years
Expected Loss = Expected Default frequency * (Exposure – Security) * Loss Given Default.
70 60 50
A downgrade impacts on the Expected Default Frequency (or Probability of Default) and on the Loss Given Default. The Risk Premium for the same issuer therefore substantially increases and the banks need to set more money aside.
40 30 20 10
C Caa-C
B3
B2
B1
Ba3
Ba2
Ba1
Baa3
Baa2
Baa1
A3
A2
A1
Aa3
Aa2
Aa1
Aaa
0
Some loan documentations contain rating triggers or margin grids linked to ratings. A downgrade could lead to higher interest payments, the provision of additional securities, partial mandatory early prepayment or even to the acceleration of the loan. This circle might further accelerate the downgrade cycle. According to EU Regulation, Rating Agencies need to act as soon as they become aware of new information. Rating Agencies should monitor on an on-going basis the performance of the Issuer and make an update at least annually.
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers
A WORD ON UNSOLICITED RATING
Credit institutions
Rating Agency
The EU Regulation states: Pension Funds
An unsolicited credit rating, namely a credit rating not initiated at the request of the issuer or rated entity, should be clearly identified as such and should be distinguished from solicited credit ratings by appropriate means. A credit rating agency shall disclose its policies and procedures regarding unsolicited credit ratings. When a credit rating agency issues an unsolicited credit rating, it shall state prominently in the credit rating whether or not the rated entity or related third party participated in the credit rating process and whether the credit rating agency had access to the accounts and other relevant internal documents off the rated entity or a related third party.
Communicating with Rating Agencies By Thomas Missong
Issuer Insurance Reinsurance
UCITS
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Rating R ti A Agencies i might i ht assign i U Unsolicited li it d R Ratings ti as: - It corresponds to their business model - It is keen to enter into a market and assign reference g ratings - It is keen to convert an unsolicited rating into an solicited one (against a fee)
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Note: an Unsolicited Rating is not necessarily below a Solicited rating
DAVOS – February 2010
World Forum for Communication Top-Managers
CONTACT
Mag. Thomas Missong, M.A., CRA (BdRA) Währingerstr 61 / Top 4 Währingerstr. 4.07, 07 A A-1090 1090 Wien Wien, Austria Email: thomas.missong@aon.at Mobile: +43 676 380 73 44 F +43 1 25 33 0 33 49 59 Fax:+43
Communicating with Rating Agencies By Thomas Missong
DAVOS – February 2010
World Forum for Communication Top-Managers