Session II: Issuer-Pay vs. Investor-Pay Business Model
Mark Adelson Executive Managing Director Senior Research Fellow
Debt Rating Agencies’ Role in the Global Debt Capital Markets: Past Present and Future Global Interdependence Center & CFA Society of Philadelphia 29 February 2012
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Impetus for Change • The big picture of S&P ratings performance is good… – Rank ordering of default rates by rating category within key sectors – Good Gini coefficients over multiple time horizons
• …but some sectors were outliers… – Residential mortgage-backed securities (RMBS – CDOs of ABS (backed by RMBS) – Bond insurance – Banks
• …which disappointed the market’s expectations… • …and hurt the firm’s credibility
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2.
Impetus for Change: Example – Structured Finance Ratings
Adverse Credit Migrations of 2005-2007 Vintages of U.S. RMBS, CDOs of ABS, and SIV Lites Original Rating
Status as of 31 December 2010 Default + Near Default
Default
Near Default
Any Downgrade
No. of Ratings
AAA
60.1%
22.7%
37.4%
77.3%
4,043
AA
78.2%
45.8%
32.4%
87.6%
8,340
A
88.5%
59.7%
28.8%
93.4%
7,456
BBB
94.0%
69.4%
24.7%
95.2%
7,806
82.8%
52.8%
30.0%
89.8%
27,645
Inv. Grade
Note: 'AAA' ratings from the same transaction are treated as a single rating in this table's calculation. Multiple rating actions are aggregated to calculate a security's cumulative rating performance. Near default means rated 'CCC+' or lower. Source: Erturk, E., Global Structured Finance Securities End 2010 With Rising Credit Stability (7 Feb 2011) (Table 6a).
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3.
Impetus for Change: Example – Financial Firm Ratings ICR at 1/1/07
Δ Eq Px 2007-08
AIG
AA+
-97.7%
~$183b in bailouts. US govt owns 80% stake
Bear Stearns
AA-
-94.2%
Shotgun marriage with JP Morgan for $10/share
Citigroup
AA
-86.7%
Hybrids exchanged, U.S. gov’t took 36% equity
IndyMac
BBB
-99.6%
Seized by FDIC in 2008, auctioned off in March 2009
Lehman
AA-
-100.0%
Merrill Lynch
AA-
-18.1%
Bought out by B-of-A 9/14/2008
Northern Rock
A+
-92.4%
Nationalized 2/22/2008
RBS
AA
-92.6%
Part nationalization, UK gov’t holds 84% stake
UBS
AA+
-76.3%
Write-downs >$50B since 2007
Wachovia
AA-
-89.3%
“Silent run" in Sep 2008; acquired by Wells Fargo
WaMu
A
Fannie Mae
AA-
-98.6%
Freddie Mac
AA-
-98.9%
Company
-100.0%
Notes
Bankruptcy 9/15/2008.
Receivership 9/25/2008 Conservatorship 9/7/2008. U.S. Treasury holds preferred stock and warrants worth 80% stake
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4.
Impetus for Change: Example – Financial Firm Ratings (#2) ICR at 1/1/07
Δ Eq Px 2007-08
Ambac
AAA
-98.5%
Bankruptcy 11/8/2010
MBIA
AAA
-94.3%
Rated B, attempting restructuring
FGIC
AAA
n.a.
Bankruptcy 8/3/2010
FSA
AAA
n.a.
Acquired by AGC in July 2009
ACA
A
n.a.
Restructuring plan 8/8/2008
AGC
AAA
-56.4%
CIFG
AAA
n.a.
Company
Notes
Now rated AA-
CC rating withdrawn 2/16/2010
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5.
Key Criteria Goals • Comparability – Each rating symbol – for example, 'AAA‘ – to connote a comparable view of creditworthiness, wherever and whenever it appears – Provides a common vocabulary for discussing credit risk – Achieved through application of common stress for each rating category – Use historical studies as part of criteria calibration (e.g., NBER papers)
• Transparency – Allows users to understand how S&P reaches rating conclusions (the “what”) – Clearer definition and weighting of variables driving the conclusion – Rationales explaining choice of methodology and assumptions (the “why”)
• Harmonization – Similar factors analyzed consistently across sectors (e.g., management, default rate simulation parameters, treatment of guarantees)
• Simplification – Common design framework: key elements, scoring, roll-up – Modularization (plug and play components) – Ease of application
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6.
Behind the Goals • Comparability makes S&P ratings more relevant to those responsible for top-level asset allocation and investment policy decisions • Superior comparability and transparency positively differentiate S&P ratings from our competitors’ • Leading the credit rating industry… – Moody’s, “Recalibration of Moody’s U.S. Municipal Ratings to its Global Rating Scale” (March 2010) – Fitch, “Ratings Comparability” (21 June 2010)
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7.
Delivering Comparability • Retrospective – Gini coefficients (rank ordering power) – Comparing default rates across sectors, regions, and over time
• Prospective – Common approaches to risk analysis (harmonization) – Stress scenarios for criteria calibration
Criteria Calibration Stress Scenarios – Key Parameters
AAA
AA
A
BBB
BB
B
-26½%
-15%
-6%
-3%
-1%
-½%
Unemp.
25%
20%
15%
10%
8%
6%
Equities
-85%
-70%
-60%
-50%
-25%
-10%
ΔGDP
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8.
Understanding S&P Rating Definitions (3 Jun 2009) • Ratings are forward looking and reflect views on relative ranking of overall creditworthiness • S&P ratings are not just opinions of likelihood of default – Likelihood of default – Payment priority
– Recovery – Credit stability
• New stress scenarios adopted to further our goal of comparability across sectors, geographies and time • 'AAA' (“extreme”) stress scenario is based on the Great Depression – AAA face greater possibility of default under extreme scenario – AAA are likely to face more transitions with increasing decline in economy
• Stress scenarios used as a calibration tool for criteria
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9.
Delivering Transparency • Criteria design framework – Creating a path for replicability Step 1: select items that drive creditworthiness Step 2: define methods for scoring/ranking/grading each selected item Step 3: define system for combining scores from step 2 into a final rating
– Allows for future modularization of criteria components (e.g., management, group support, etc.) – Gives criteria articles a consistent structure to make the entire body criteria easier to navigate and manage – Embraces both quantitative and qualitative aspects of analysis – Emphasizes objectivity and establishing a factual basis for qualitative judgment
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10.
Criteria Project Examples • Substantive changes – CMBS (26 Jun 2009) – RMBS (10 Sep 2009) – Corporate CDOs (17 Sep 2009) – Covered Bonds (16 Dec 2009) – Counterparty (6 Dec 2010, proposed update 21 Nov 2011) – Bond insurers (25 Aug 2011) – Banks (9 Nov 2011)
• Creating a rigorous and systematic process – U.S. States (3 Jan 2011)
– Sovereigns (30 Jun 2011)
• Transparency emphasis in all of the above
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11.
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