Understanding and Managing the Credit Rating Agencies A Guide for Fixed Income Issuers Roger P Nye E U R B O O M O O K N S E Y
Preface Glossary List of exhibits Acknowledgements About the author xiii xv xvii xix xxi Part 1 - Understanding the rating agencies 1 Getting started 3 Precis 3 1.1 The basics 4 Definitions and benefits 4 Rating symbols and meanings 8 1.2 Information asymmetry 12 Seilers, buyers and intermediaries 12 Transparency and the agencies 13 Recent changes 14 1.3 Rating agency principles and practices 15 Underlying principles... and the impact on issuers 15 Principle 1: the substance and appearance of credibility 15 Impact on issuers 16 Principle 2: the need for secrecy 16 Impact on issuers 17 Principle 3: better too low than too high 17 Impact on issuers 18 Principle 4: incomplete, insufficient or suspect data 18 Impact on issuers 18 Underlying practices... and the impact on issuers 19 Practice 1: obscure Operations and mysterious processes 19 Impact on issuers 19 Practice 2: rule-maker, agenda-controller 20 Impact on issuers 20 Practice 3: rating committee membership 21 Impact on issuers 21 Practice 4: in line with market realities 21 Impact on issuers 22 Ratings and the prices of bonds 22 1.4 The business of ratings 24 Reputation and trust 24 Vll
Confidentiality and ethics Wanted: experienced analysts Emerging market CRAs 1.5 Rules and secrecy Myths and misunderstandings One-way street 1.6 Rating agency fees Fees vary and are negotiable 1.7 Choosing a rating agency Ask these questions 2 The nature of credit ratings Precis 2.1 Inherent subjectivity Informed guesswork behind ratings Statistics and ratings 2.2 Projected Performance The basis of forecasts 2.3 Ratings as lagging indicators Agency response Why ratings are 'late' 2.4 What makes a rating right? Right ratings The bond market's view 2.5 What makes a rating wrong? Wrong ratings Negligent but infrequent 2.6 What causes split ratings? Fundamental discrepancies Investment grade or not? Three takeaways 2.7 Unsolicited ratings Moody's justification Current practice Issuer options 2.8 Are ratings really globally comparable? Basier said than done 2.9 Stable outlooks are not stable 2.10 The myth of monitoring Steps to take and questions to ask 3 Convictions and regulations Precis 25 26 28 30 30 31 32 32 33 33 35 35 36 36 36 38 38 39 39 39 41 41 42 44 44 45 47 47 49 49 50 50 52 53 55 55 56 58 60 61 61 viii
3.1 Transparency - the higher hurdle 62 Guide to agency thinking 62 Main lessons 63 3.2 Agency convictions on corporations 65 Fundamental Conventions 65 General guidelines 66 Management delivery 67 The analytical pyramid 68 The sovereign environment 68 The industry setting 68 The regulatory environment 69 The operating climate 69 Organisational structure 70 Special event risk 70 Quality of management 70 Risk management culture 70 Statistical measures 71 Corporate governance 72 Corporates in emerging markets 74 Extemal Support 74 The due diligence meeting 75 Advice for issuers 77 3.3 Agency beliefs on banks 79 Inherent fragility and red flags 80 Context, character and controls 82 Banks in emerging markets 84 Determinants of Upgrades 86 Determinants of downgrades 87 3.4 Charges against the agencies 89 Nine accusations 89 Managing potential conflicts of interest 93 Fed study supports agency position 93 Conclusion 93 3.5 Regulating the raters 95 Background to the business 95 Agency role imbedded in law 96 The Dodd-Frank Act, 2010 98 No reasonable alternatives 99 Shift in methodology 100 The cast of culprits 101 Overseas oversight 102 EU rules on CRAs 103 Conclusions 106 Observations for issuers 107 ix
Part 2 - Managing the rating agencies 4 The rating meeting 111 Precis 111 4.1 Proper preparation is paramount 112 Essential steps 112 Direct questions 114 Conclusion 115 4.2 Your critical Performance 116 Perceptions of Performance 116 TheABCs 118 4.3 Presentation format and tactics 120 Fifteen tactics 120 Summaiy of key points 126 4.4 Useful and non-usefui information for the agencies 128 What is most useful to the rating agencies 128 What is least useful to the rating agencies 129 Steps to take and questions to ask 130 5 The rating committee 131 Precis 131 5.1 How the rating committee works 132 Caution rules 132 Qualitative versus quantitative 133 Bank analysts 133 Sovereign analysts 134 Corporate analysts 134 The rating committee did whatf 135 5.2 Constraints to an Upgrade 137 Constraints relative to rating agency fundamental 137 Constraints relative to the lead analyst 138 Constraints relative to rating committee dynamics 138 Lessons from all these constraints 140 5.3 The press release 142 Crafting equivocation 142 5.4 The appeal process 144 Overcoming the hurdles 145 6 The proactive approach 147 Precis 147 6.1 Communicating with the agencies 148 Open communication is a necessity 148 Allies, not adversaries 148 x
Issuer alerts 149 Contact person 150 The two-way street 151 6.2 Issuer rights and leverage 153 List of issuer rights 154 6.3 Rating agency retaliation 156 Checks and balances 156 Safeguards are effective 157 Conclusion 158 6.4 The tipping point 159 The due diligence meeting 159 Rating committees 159 The choices of management 160 6.5 What not to say and do 161 A missed opportunity 161 Consequences 164 Conclusions 165 6.6 Raising the odds for an optimal rating 167 Overcoming the obstacles 167 A ratings success formula 168 Step 1: strategy 169 Step 2: Performance 170 Step 3: persistence 170 6.7 Whistling in the dark 172 Seventeen excuses 172 6.8 Cutting connections with the CRAs 176 Negative consequences 176 7 The sovereign setting 179 Precis 179 7.1 Globalisation and credit ratings 180 Erosion of sovereign power 180 The ratings impact 181 The expansion of ratings 182 Thomas Friedman 182 Conclusions 183 7.2 Agency suppositions on sovereigns 185 Major tenets 185 Beliefs about government policy and management 187 Fiscal policy 189 The external accounts 190 Debt policy 192 Inflation and unemployment 194 The fundamental variable 195 XI
7.3 An ideological bias in sovereign ratings 197 Generating wealth 197 The rule of law 197 7.4 Does politics matter? 199 The US position 199 7.5 Ratings as report cards 201 Policy settings are crucial 201 Conclusion 202 7.6 Policy, policy, policy 203 Policy settings and successes 203 Options and constraints 204 7.7 Corruption and ratings 206 Incentive killer 206 The agency views 207 7.8 Culture and ratings 209 7.9 Governance at the government level 210 Governance and ratings 210 World Bank definition 210 Governance and the private sector 213 7.10 Sovereign Upgrades and downgrades 214 Reasons behind Upgrades and downgrades 214 Practical steps for an optimal rating 217 Steps to take and questions to ask 218 Part 3 - Appendices 1 The credit information bureau 221 The GIB 221 GIB basics 221 The systemic benefits of CIBs 222 Similarities between CIBs and CRAs 222 Differences between CIBs and CRAs 222 2 Agency analyst anecdotes 223 3 The role of a ratings adviser 225 Xll