48
rating service, Moody’s usually only gives point in time
confidential ratings (“indicative ratings”). S&P maintains
confidential credit ratings periodically similar to a public rating
and the rating can be published on request. Public
dissemination of a private credit rating is not permitted.
Other considerations
Guidance provided publicly to debt investors concerning
ratings can give support to the rating. For example,
publicising your “target rating”, will be seen as a moral
commitment, and will give investors and agencies comfort
that you are committed to a given financial policy. Clearly this
undertaking carries its own risks.
I Credit ratings through the cycle
Although rating agencies claim to “rate through the cycle”,
this generally reflects the framework (including ratio targets)
and not the potential cyclical recovery prospects of a rated
entity. To illustrate the point, over 75% of Moody’s rating
changes in 2008 were downgrades compared to 33% in
2007. The high proportion of companies downgraded
during a recession is due to the effect of weaker trading on
credit metrics and profitability. So although the agencies
generally do not revise their methodology or guidance down
in a recession, (unless sector specific issues are identified),
they will actively downgrade companies where target
metrics are not maintained.
I “What if” rating analysis
When considering a first time rating or a rated issue, or if
unsure of the impact of a corporate event (such as an
acquisition, disposal or capital return) on an existing rating, it
can make sense to take advice from a ratings adviser. Book-
runners often offer this as part of the overall issue process
but it is important to be comfortable that the adviser is
incentivised to deliver the best possible rating (to minimise
cost of capital), rather than the lowest (necessary to get the
deal away or to support more complex structuring advice)
and an independent rating adviser may be particularly
valuable in this respect when employed at an early stage in
the process, before structure has been determined and
banks mandated. The agencies will offer a desktop credit
assessment as a rating guideline (as discussed above).
However, if greater certainty of rating outcome is required,
the agencies can provide firm rating guidance on a private
basis of rating outcome under a particular corporate scenario
(e.g. acquisition, disposal, exceptional dividend) under their
Rating Evaluation/Assessment Service. The former generally
takes two to three weeks and the latter four to eight weeks
(but both can be done more quickly in certain situations).
I Rating risk
As the capital markets become more transparent and
investors and issuers more critical, this risk is diminishing.
Issuers should remember that without anything changing in
the real world, a company rating can be changed because
the agency has decided to change its approach or
fundamental view of a sector. Changes to assessment of
pension deficits caused a number of corporates to be down-
graded in the early 2000s and, more recently, rating
approaches to financial institutions serve to remind us that
this risk should be borne in mind when planning a capital
structure around a rating target.
In the context of capital markets issues, increasing
numbers of high grade bond issuers have coupon step-ups
which are triggered by ratings downgrades (typically on
descent to non-investment grade). For those companies
maintaining investment grade credit ratings is crucial to avoid
a steep increase in interest costs.
I Bank internal credit ratings
Most banks now have their own internal risk rating scale and
since the implementation of Basel II these broadly map to
the rating agency ratings, not least because that is how they
have been designed. The bank rating processes, however,
tend to be far more numerically mechanical than those of
the agencies and consequently their scales may not be
directly comparable (also because for example their default
definition is different or they capture loss given default
differently). It should be noted, however, that almost all
banks (directly or indirectly) use Moody’s KMV to calibrate
their rating scales for expected default probability or
expected loss.
Treasurers might also be interested to know that KMV
uses (forward looking) equity market measures to map the
market value of assets to liabilities (“distance to default”) but
uses historic observed default experience of the main rating
agencies to approximate the expected default probability of
any given “distance to default”. Whether publicly rated or
not, the agencies influence ratings and cost of debt.
Recent developments
I The decline of the monolines
In 2007-2008, US sub-prime losses hit monolines’ capital
stores and ratings across the bond insurance sector were
slashed causing turmoil in the markets of the bonds wrapped
and insured by the monolines.
First to be downgraded in early 2008 were the insurers
with the largest exposures to high risk CDOs – notably,
CIFG and FGIC, soon followed by MBIA and AMBAC and
finally in November 2008 the last two remaining AAA bond
insurers, Financial Security Assurance and Assured Guaranty,
were stripped of their AAA ratings.
In downgrading the last two monolines, the agencies cited
the damage the credit crunch had inflicted on the financial
guarantee business model and how this would affect
monolines’ ability to do business. Now that monolines have
lost their AAA ratings what use are they to the structured
finance industry? In the past, demand for credit
enhancement was partly driven by regulatory capital
arbitrage; now that guarantor ratings are lower, capital
benefits may be extinguished. Moreover, when the
structured finance market does return, structures are not
likely to be as risky as the past begging the question how
Treasurer’s Companion
Capital markets and funding