Slide 1Bond rating featuresBond rating featuresRating processBond rating industryMajor playersMoody’sStandard and Poor (S&P)FitchBond Rating Grades (short-term)Bond Rating Grades (long-term)Slide 12Slide 13Agency problemRating Agency Perspective Upgrades versus DowngradesAgency problemDiscussionIn terms of S&P rating, which one is in the investment level?Slide 19SourceSlide 21Bond Rating and AgenciesWen-Hao Lo5/4/2011Bond rating featuresAssessment Information asymmetries between borrowers and lenders Ratings indicate the likelihood of the borrowed money being paid backEach agency has it own rating scale (independent assessment)EfficiencyCostly and duplicative for purchasers to do their own researchRapid dissemination of informationRatings compare relative risks of different debt issuesRatings scale is a consistent framework for comparisonsBond rating featuresDuration Last until the bond expiresChanges if there is an upgrade/downgrade in the ratings over timeMethodsQuantitative analysis: ratio analysis, economic outlook, industry analysis, company trendsQualitative analysis:management team, policy, business outlookRating processRequest ratingAssign analytical teamConduct basic researchMeet issuerRating committee meetingAppeals processIssue ratingSurveillance Source: Standard & Poor’s Corporation, S&P’s Corporate Finance Criteria (New York: Standard & Poor’s Corp, 1922), p.9.Bond rating industry“Investor pays” Model1931: rating incorporated into regulation The U.S. Office of the Comptroller of the Currency (OCC) rules1936: banks prohibited from investing in below-investment-grade bonds (the force of law)1959: Xerox (game changer)1975: SEC created NRSRO category (barrier to entry) A Nationally Recognized Statistical Rating Organization (NRSRO) is a credit rating agency which issues credit rating the SEC permits other financial firms to use for certain regulatory purposes.Early 1970s: industry switched to “Issuer Pays” ModelMajor playersThree primary agencies: Moody’s Investors Service, Standard & Poor’s (S&P) Rating Services, Fitch IBCA Inc.Moody’s Founded in 1909 by John Moody Analyses of Railroad Investments,, using letter grades to assess their risk. 1914: Moody's Investors Service was incorporated.1924: Moody's ratings covered nearly 100 percent of the US bond market.1970s: Moody's expanded into commercial debt.Announcements by Moody's of downgrades of a country's bond rating can have a major political and economic impact.Standard and Poor (S&P)1860: Henry Poor first published the History of Railroads and Canals in the United States.1906: Luther Blake founded the Standard Statistics Bureau, with the view to providing financial information on non-railroad companies.Subsequent entry into the rating business: Poor’s (1916); Standard (1922)1941: Poor and Standard Statistics merged to become Standard & Poor's Corp. 1966: S&P was acquired by the McGraw-Hill Companies, and now encompasses the Financial Services division.Standard and Poor's has become best known by indexes (S&P 500)Fitch1913: Founded by John Fitch1924: Introduced first letter scale from 'AAA' to 'D‘ (later adopted and licensed by S&P)1997: Fitch merged with London-based IBCA. 2004, Fitch developed operating subsidiaries specializing in enterprise risk management.Fitch Ratings is the smallest of the "big three" NRSROs, covering a more limited share of the market than S&P and Moody's.Bond Rating Grades (short-term)Credit Risk Moody's S&P Fitch best quality grade (exceptionally strong) P-1A-1+ F-1+ best quality grade (strong) A-1 F-1 good quality grade P-2 A-2 F-2 fair quality grade P-3 A-3 F-3 speculative nature Not Prime B B possibility of default is high C C the obligor is in default D DBond Rating Grades (long-term)Credit Risk Moody's S&P Fitch Investment GradeHighest QualityAaa AAA AAAHigh Quality Aa1, Aa2, Aa3 AA+, AA, AA- AA+, AA, AA-Upper Medium A1, A2, A3 A+, A, A- A+, A, A-Medium Baa1, Baa2, Baa3 BBB+, BBB, BBB- BBB+, BBB, BBB-Not Investment GradeSpeculativeBa1 BB+ BB+Speculative Medium Ba2, Ba3 BB, BB- BB, BB-Speculative Lower Grade B1, B2, B3 B+, B, B- B+, B, B-Speculative Risky Caa1 CCC+ CCCSpeculative Poor StandingCaa2, Caa3 CCC, CCC- --No Payments / BankruptcyCa / C -- --In Default -- D DDD, DD, D“There are two superpowers in the world today in my opinion. There's the United States and there's Moody's Bond Rating Service. The United States can destroy you by dropping bombs, and Moody’s can destroy you by downgrading your bonds. And believe me, it’s not clear sometimes who’s more powerful.” Thomas L. Friedman, PBS “News Hours” Feb. 13, 1996Agency problemRating preferenceMoody’s rate slightly more negatively on average than S&PMoody’s is more likely than S&P to be the first agency to initiate a rating change, S&P is arguably more aggressive about their ratings.Moody’s is more negative rater for small issue and issuer, and for more highly levered firms. Split rating: S&P 94; Moody’s 36Rating Agency Perspective Upgrades versus Downgrades•S&P reported more upgrades than downgrades in 2010 – the first time this occurred since 2006.•The downgrades convey bad news to holders, but upgrades are less informativeAgency problemConflict of interest: Bond rating agencies earn revenues from fees paid by bond issuers.Rating shopping: High fee groups get better bond rating than Low fee groups.Free rating: Rating agencies offer free service. Jefferson County, Colorado School District: general obligation bonds (Oct, 1992) Moody’s : A2 Rating Fee VS. 1st AmendmentDiscussionIf you were a bond issuer, would you join the rating or not? Why?If you were an investor, how would you interpret the rating? Why?In terms of S&P rating, which one is in the investment level?a. BBB-b. Baa3c. BB+In terms of Moody’s rating, which one is in the speculative level?a. BB-b. Baa3c. Ba1Source (S&P):http://www.standardandpoors.com(Moody’s):http://www.moodys.com(Fitch IBCA):http://www.fitchibca.com(SEC): http://www.sec.gov http://www2.standardandpoors.com/spf/html/media/SP_TimeLine_2006.html. Retrieved April 25, 2011.Standard & Poor’s Corporation, S&P’s Corporate Finance Criteria (New York: Standard & Poor’s Corp, 1922), p.9.Timothy J. Sinclair, The New Masters of Capital (New
View Full Document