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COMMUNICATING EFFECTIVELY WITH RATING AGENCIES 1. Ratings g defined 2. Communicating with Rating Agencies

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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

•

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

• •

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

•

Degree of complexity of an agency: - The bigger an agency gets, the less people you will know!

- Number of methodologies

•

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.

•

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:

•

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

•

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.

•

Rating agencies may use “credit Watch” or “evolving”, in this case it is hard to guess the rating action.

Industry specific reasons

• •

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

•

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)

•

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