Credit Rating Agencies
Content
SEC Examinations Find Shortcomings in Credit Rating Agencies' Practices and Disclosure to Investors, July 8, 2008
The SEC staff's examinations found that rating agencies struggled significantly with the increase in the number and complexity of subprime residential mortgagebacked 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.
In 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. In 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, AIG and Lehman bonds alone account for $1,800bn nominal of agency-rated corporate debt. 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.
But they cannot remain silent forever. To avoid the heavy burden of a regulatory fate, the rating agencies must take action soon. The world of independent credit opinion needs more competitors for their own survival outside the regulatory impulses of the government. 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 – do not blindly rely on the CRA. Global 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 – cra were blamed for their generous rating of dubious mortgage linked instruments during boom.
Inherent conflict of interest Adverse Business Model Ratings are opinion and not guarantee.s Recently concluded G 20 summit calls for globally consistent standard on International Organization of Securities Commission (IOSCO) proposals to put appropriate procedures in place
1.Standard & Poor, 2. Moody's Investor Services and 3. Fitch Ratings All 3 are under regulatory scrutiny for their passive role in the 2007 US residential mortgage backed securities (RMBS) crisis. - Key role in the bankruptcy of California based Orange County – 1994. Orange County a very rich municipality in California went bankrupt due to speculation in derivatives. However CRA had given good rating. - Giving superior investment grade to Enron in 2001. - Role was reactive in Asian crisis rather than being proactive.
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. The Moody's rating system is similar in concept but the verb age is a little different. It is as follows: AAA, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C.
Country risk rankings Euromoney Country risk March 2008 Least risky countries, Score out of 100 Ratings are further broken down into components including political risk, economic risk. 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)
Rank
1 2 3
Previous
1 2 3
Country
Luxembour g Norway
Overall score
99.88 97.47
Switzerland 96.21
4
5 6 7
4
5 6 10
Denmark
Sweden Ireland Australia
93.39
92.96 92.36 92.25
CRISIL, Credit Rating Information services of India LTD. From a pioneering step taken in 1987, to playing an integral role in India's development milestones, CRISIL has emerged as India's leading Ratings, Research, Risk and Policy Advisory company. CARE Credit Analysis & Research Ltd. (CARE), incorporated in April 1993, is a credit rating, information and advisory services company promoted by Industrial Development Bank of India (IDBI), Canara Bank, Unit Trust of India (UTI) and other leading banks and financial services companies. In all CARE has 14 shareholders ICRA , Investment Credit Rating Agency of India Ltd (an Associate of Moody's Investors Service) was incorporated in 1991 as an independent and professional company. ICRA is a leading provider of investment information and credit rating services in India. ICRA’s major shareholders include Moody's Investors Service and leading Indian financial institutions and banks.
Onicra – SSI and SME rating – approved by the Govt of India and Indian banks association. NSCI is its nodal agency Rating 1A, 1B, 1C – 5A, 5B ,5C( high to Poor) SME rating agency of India (SMERA) (1995) is a joint initiative by SIDBI, Dun & Bradstreet Information Services India Private Limited (D&B), and several leading banks in the country. -- Objective is to enhance credit flow to credit-constrained SME sector. It 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’.
CRISIL’s association with Standard & Poor’s, a division of The McGraw-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 CRISIL.
Ratings and Risk Assessment CRISIL Ratings CRISIL Ratings is the only ratings agency in India to operate on the basis of sectoral specialisation. It reflects sharpness of analysis, the responsiveness of the process and the large-scale dissemination of opinion. CRISIL Ratings plays a leading role in the development of the debt markets in India. 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 McGrawHill 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 India.
CARE has been granted registration by SEBI under the Securities & Exchange Board of India (Credit Rating Agencies) Regulations,1999. 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 India. CARE is well equipped to rate all types of debt
To increase investor confidence and guide them Facilitate decision making Measures probability of default to meet obligations Strengths and weaknesses of the company Rated instrument enjoys higher confidence
Provide information and guidance to institutional and individual investors/creditors. 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. Assist the regulators in promoting transparency in the financial markets. Provide intermediaries with a tool to improve efficiency in the funds raising process.
CRA are not auditors Credit rating changes with time Judgment in India is a mix of quantitative and qualitative factors Is it necessary to regulate CRA
Solicited or Unsolicited ratings
Regulating the Raters
Credibility arises from objectivity of resource allocation Rating agencies are not and should not assume the role of regulators Continued growth and evolution of the credit rating business would depend on the size and the growth of the debt market.
CR involves subjective judgment with objective analysis Rating shopping is a cause of concern Lack of transparency on the part of CRA In most country’s CRA are not regulated Credibility arises from objectivity of resource allocation
Fuzziness of data Readiness/ Reluctance of the company in disclosing information Proper control systems are not in place Credibility of the agencies carrying out the rating Industry is still young Fuzziness of data
Z = 1.2 X1 + 1.4 X2 + 3.3 X3 +0.6 X4 + 1.0 X5 Where X1 = W.K. / TA X2 = RE / TA X3 = EBIT / TA X4 = MV of equity / BV of debt X5 = Sales / TA Z is less than 1.81 Z is greater than 2.99
Conclusions Still Young Foreign CRA entering India, quality will improve No credit rating association Attempt to develop core competencies
Do rating agencies conduct a primary audit? Is it mandatory for the rating agencies to follow international norms? Can the rating agencies demand information as a matter of right? Is an appraisal in continuum required?
SEC Examinations Find Shortcomings in Credit Rating Agencies' Practices and Disclosure to Investors, July 8, 2008
The SEC staff's examinations found that rating agencies struggled significantly with the increase in the number and complexity of subprime residential mortgagebacked 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.
In 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. In 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, AIG and Lehman bonds alone account for $1,800bn nominal of agency-rated corporate debt. 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.
But they cannot remain silent forever. To avoid the heavy burden of a regulatory fate, the rating agencies must take action soon. The world of independent credit opinion needs more competitors for their own survival outside the regulatory impulses of the government. 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 – do not blindly rely on the CRA. Global 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 – cra were blamed for their generous rating of dubious mortgage linked instruments during boom.
Inherent conflict of interest Adverse Business Model Ratings are opinion and not guarantee.s Recently concluded G 20 summit calls for globally consistent standard on International Organization of Securities Commission (IOSCO) proposals to put appropriate procedures in place
1.Standard & Poor, 2. Moody's Investor Services and 3. Fitch Ratings All 3 are under regulatory scrutiny for their passive role in the 2007 US residential mortgage backed securities (RMBS) crisis. - Key role in the bankruptcy of California based Orange County – 1994. Orange County a very rich municipality in California went bankrupt due to speculation in derivatives. However CRA had given good rating. - Giving superior investment grade to Enron in 2001. - Role was reactive in Asian crisis rather than being proactive.
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. The Moody's rating system is similar in concept but the verb age is a little different. It is as follows: AAA, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C.
Country risk rankings Euromoney Country risk March 2008 Least risky countries, Score out of 100 Ratings are further broken down into components including political risk, economic risk. 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)
Rank
1 2 3
Previous
1 2 3
Country
Luxembour g Norway
Overall score
99.88 97.47
Switzerland 96.21
4
5 6 7
4
5 6 10
Denmark
Sweden Ireland Australia
93.39
92.96 92.36 92.25
CRISIL, Credit Rating Information services of India LTD. From a pioneering step taken in 1987, to playing an integral role in India's development milestones, CRISIL has emerged as India's leading Ratings, Research, Risk and Policy Advisory company. CARE Credit Analysis & Research Ltd. (CARE), incorporated in April 1993, is a credit rating, information and advisory services company promoted by Industrial Development Bank of India (IDBI), Canara Bank, Unit Trust of India (UTI) and other leading banks and financial services companies. In all CARE has 14 shareholders ICRA , Investment Credit Rating Agency of India Ltd (an Associate of Moody's Investors Service) was incorporated in 1991 as an independent and professional company. ICRA is a leading provider of investment information and credit rating services in India. ICRA’s major shareholders include Moody's Investors Service and leading Indian financial institutions and banks.
Onicra – SSI and SME rating – approved by the Govt of India and Indian banks association. NSCI is its nodal agency Rating 1A, 1B, 1C – 5A, 5B ,5C( high to Poor) SME rating agency of India (SMERA) (1995) is a joint initiative by SIDBI, Dun & Bradstreet Information Services India Private Limited (D&B), and several leading banks in the country. -- Objective is to enhance credit flow to credit-constrained SME sector. It 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’.
CRISIL’s association with Standard & Poor’s, a division of The McGraw-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 CRISIL.
Ratings and Risk Assessment CRISIL Ratings CRISIL Ratings is the only ratings agency in India to operate on the basis of sectoral specialisation. It reflects sharpness of analysis, the responsiveness of the process and the large-scale dissemination of opinion. CRISIL Ratings plays a leading role in the development of the debt markets in India. 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 McGrawHill 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 India.
CARE has been granted registration by SEBI under the Securities & Exchange Board of India (Credit Rating Agencies) Regulations,1999. 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 India. CARE is well equipped to rate all types of debt
To increase investor confidence and guide them Facilitate decision making Measures probability of default to meet obligations Strengths and weaknesses of the company Rated instrument enjoys higher confidence
Provide information and guidance to institutional and individual investors/creditors. 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. Assist the regulators in promoting transparency in the financial markets. Provide intermediaries with a tool to improve efficiency in the funds raising process.
CRA are not auditors Credit rating changes with time Judgment in India is a mix of quantitative and qualitative factors Is it necessary to regulate CRA
Solicited or Unsolicited ratings
Regulating the Raters
Credibility arises from objectivity of resource allocation Rating agencies are not and should not assume the role of regulators Continued growth and evolution of the credit rating business would depend on the size and the growth of the debt market.
CR involves subjective judgment with objective analysis Rating shopping is a cause of concern Lack of transparency on the part of CRA In most country’s CRA are not regulated Credibility arises from objectivity of resource allocation
Fuzziness of data Readiness/ Reluctance of the company in disclosing information Proper control systems are not in place Credibility of the agencies carrying out the rating Industry is still young Fuzziness of data
Z = 1.2 X1 + 1.4 X2 + 3.3 X3 +0.6 X4 + 1.0 X5 Where X1 = W.K. / TA X2 = RE / TA X3 = EBIT / TA X4 = MV of equity / BV of debt X5 = Sales / TA Z is less than 1.81 Z is greater than 2.99
Conclusions Still Young Foreign CRA entering India, quality will improve No credit rating association Attempt to develop core competencies
Do rating agencies conduct a primary audit? Is it mandatory for the rating agencies to follow international norms? Can the rating agencies demand information as a matter of right? Is an appraisal in continuum required?
