Financial Rating

Credit ratings and debt ratings or rating (in the Anglo-Saxon) is the assessment by a rating agency , the risk of solvency Financial:

• a company ,
• a State ("sovereign rating") or another public authority, national or local
• a transaction (loan, bond , structured finance transactions, securitization , ...)

and assigning a score corresponding to the repayment prospects of its commitments to its creditors - suppliers , banks , holders of bonds ...

The credit rating is, for investors, a key criterion in estimating the risk that an investment entails, particularly in the context of financial markets become more global, which makes it difficult to control information and therefore all risk parameters. It is even a mandatory criteria for corporate borrowers ( pension funds , local authorities , etc..) whose statutes specify a minimum level of rating for their investments.

It is essential to distinguish between credit ratings and risk assessments receivable , which may have the same goals (to deal with counterparty risk ) but not using the same resources (the first uses a real financial audit and the other uses an expert system - automatic). Also, the rating is sought (often by large listed companies), while the assessment is systematic and carried out on all businesses.

The task of conducting the financial analysis necessary to assign the note is assigned to rating agencies.

The rating of credit rating agencies

The ratings of financing instruments to medium (more than a year) or long term (10 years or more) range from AAA (triple A) credit quality of the highest, to D, found default or imminent.

The short-term rating to judge the debtor's ability to fulfill its commitments to one year. The long-term rating considers the debtor's ability to meet its obligations over a year.

The higher the score is good, unless the issuer of the bond will pay dearly.

The table below details the cons rubrics long term and short term than the three major rating agencies provide.

As seen, the long-term rating is more detailed than the short-term rating. For example, companies that received long-term rating from Fitch "AAA" to "AA-" will receive the same short-term rating 'F1 +'. It is understandable because even intuitively that two companies that have a risk of long-term default slightly different (more important for society "AA-" for society "AAA") will, in the short term, a risk almost identical.

Rating process

Criteria

The criteria on which the agencies are based, although each has its own methods, which depend on the mission is entrusted:

• Companies: accounting criteria, management, risk assessment, economic opportunities, ...
• State: economic situation, stability, monetary and fiscal policy, ...
• Operation: modeling of the operation and its cash flows to enable an assessment of default risk and possible loss.

Methodology

In practice, the agency has authorized access to all documents and officials of his client. The initial process will take several weeks of intensive contacts and analysis, after which the agency provides a rating for its customer.

At this stage, the unhappy customer can simply decline it, in which case the note will not be published (and the contract with the agency probably broken ... after payment of the agreed commission).

If the contract with the agency is maintained (and scoring normally made public), the agency may revise the rating at any time, whether following the occurrence of a particular (economic, sudden loss of customers , ...) or as a result of regular visits to the client (usually at least once a year).

The review may lead to a change in scoring (increase or decrease the rating) or put under surveillance. A supervision order is involved with positive or negative and opens a limited period of time during which the agency finalizes its position (usually no more than a month). The agency is totally free in this process. The client has not the slightest possibility of preventing the agency to publish, without even notifying, a revision of the note. In 1995, the Canadian government learned, along with the market, Moody's placed the rating of the country on negative watch.

It is not uncommon to find in the trade press echoes of customers not satisfied with the financial ratings given to them, or changes thereof, which is, somehow, a pledge of independence of the latter.

Provision of Information

The ratings are public and can be consulted on a variety of sources such as Bloomberg or SIX Telekurs or agency websites.

Rating agencies are generally available, fee, additional tools such as:

• statistical analysis by sector,
• collection tools for portfolio ratings,
• study of particular problems in taking corporate finance,
• Detailed reports by company
• historical analysis (defects corporate ratings migration matrix, ...)
• ...

Some categories applicable credit rating

Credit rating - credit score

Strictly speaking, the financial rating as described here is a concept that relates to the financial markets and therefore the actors in financial markets : companies, states, etc..

But there is a parallel in two areas:

• the field of unlisted SMEs and micro businesses (ie the risk assessment-client - as part of the counterparty risk to the difference in credit ratings, rating evaluation is performed automatically on the basis of information financial and legal.)
• individuals, rather we designate under the term credit score, which is a rough measure of repayment capacity.

If in Europe, this type of score is determined by each bank's own credit policy and risk assessment, there are countries, including the United States, where there are rating agencies specific to this type of risk. The criteria used are, in this case, income, existing credit, credit history

Notation debtor - Rating transactions

The credit rating of a debtor's interest in the overall capacity of the obligor to meet its commitments.

Such a rating does however information on the situation "now" of the debtor, so one can also note a single operation.

A single operation (such as a loan or bond issue) will be denoted by example:

• at the conclusion of a new loan (new loan is changing the financial structure of the borrower and therefore may affect its ability to repay)
• when the operation has a peculiarity that makes his chances of repayment are improved or worse:
  • The loan is secured by such a pledge , a mortgage or other form of security or safety (reduction of the loss on default)
  • the loan is structured transaction (reducing the likelihood of default and loss on default)
  • the loan is a transaction subject (increased probability of default and loss on default).

Scoring - Scoring in foreign currency

Scoring unspecified measures the ability of repayment in general, while the foreign currency rating measures the ability to repay foreign currency.

This distinction is not necessarily always done, but appears indirectly, for example due to the rating of a foreign currency borrowing.

Thus, the notation of a U.S. dollar loan from a European company will depend on access of this company to a source of U.S. dollars.

The notation in this motto is often especially when it comes to rating a state. In this case, the difference in rating reflects the fact that a state will tend to focus on the repayment of debts expressed in national currency, which in principle implies a lower rating for borrowings in foreign currency.

sovereign rating - ceiling and concept of "country risk"

States (and other public bodies), like firms, can be rated financially, whether developed countries (eg those in the euro area ) or the third world.

Besides the peculiarities involved in analyzing the creditworthiness of the state itself (including the impact of fiscal capacity on its ability to repay) and consequences (definition of acceptable debt limit for sovereign debt ) The sovereign rating may also affect the ratings of local businesses and their debt limits. Rating agencies may consider a company working primarily in one country can not, regardless of its financial strength, overcome limitations related to monetary policy, fiscal and budgetary policy. Companies' credit insurance use these ratings to assess "country risk" for export operations in particular.

Impact of credit ratings

Risk Premium

The credit rating of a market participant is an important element in making an investment decision.

Without being able to fully replace, at least in principle, the personal analysis by the investor, the financial rating of a company is an essential part of making an investment decision.

At the top of the pyramid, we find the AAA rating, usually reserved for a few states. It is there in the area of investment (virtually) risk free.

An investor therefore will not consent to invest in a borrower with rating lower than the payment of an interest rate including a risk premium supposed to cover the risk of loss.

The financial rating scales have therefore become a necessary reference for financial markets , with establishment of a scale of risk premiums.

This scale of risk premium is:

• nor static: and there will be economic circumstances as a broadening or narrowing of risk premiums,
• nor unique: if one sector of industry is perceived by the market as more risky, such as the telephone sector, the premium for a borrower in this sector will be higher;

However, we find that the scale will always respect this basic rule: the higher the financial rating, the lower the premium.

Globalization

In a global economy where capital flows freely, the rating agencies are an important development. Without a credit rating in which the investor can trust, it is partly an illusion to promote the free movement of capital, an investor getting involved when it comprises, or understands the risks it faces.

So it's no coincidence that the financial rating has become more common in Europe since the advent of the Euro and the creation of a financial market in Euro-boundaries of member states of the eurozone.

Risk Management

Who says global economy said the overall risk. Market regulators found themselves facing the last two decades the issue of risk management by market players and financial system stability.

It is noted that the rating agencies have become so essential that regulators require them to use market players.

The most striking example is the current evolution of international banking regulation.

Thus, the agreement says "Basel II" established under the auspices of the Committee on Banking Supervision of the Bank for International Settlements (BIS), which will be transcribed in the form of a binding directive to all banks the European Union , because of the financial risk rating by an independent agency a key tool for managing credit risk by banks.

Reviews

Negative impact on the economy

Credit ratings have become an essential element of financial markets so that the announcement by an agency of the fall of a rating has an immediate impact on the cost of financing the business (or state).

Some call this a vicious circle: the higher cost of credit may make it more difficult to resolve business problems and creating new ones, but this criticism loses sight of the central purpose of a rating agency, namely the dissemination of objective financial information that, by allowing investors to measure their risk facilitates the flow of capital to healthy firms. From there, the existence of independent rating agencies is a positive factor for the economy in general.

In fact, while the case Enron had already raised questions about the true independence of agencies, most recently the subprime crisis has challenged the concept of independence used by rating agencies. Indeed, agencies have been very involved in the development of the market complex structured transactions, defendants, to the extent that banks used mathematical models created directly by agencies. Moreover, the concept of identical credit ratings for companies and structured transactions is questioned ^References

See also

Internal Links

• Credit Insurance
• Rating Agency
• Basel II
• Repayment capacity
• Customer Risk Assessment
• Corporate Finance
• Junk bond
• Sovereign rating of countries in the euro area
• Obligation
• Credit Risk

External Links

• BIS - Bank for International Settlements - Basel Committee
• (In) Washington Post article on the influence of rating agencies

Key players in the market

• FitchRatings
• Moody's
• Standard & Poor's

Leading economists, rating agencies

• Frank Packer (Bank for International Settlements)
• Edward Altman (NYU)
• Helmut Reisen (OECD) ( http://en.orgHelmut_Reisen )
• Norbert Gaillard (Sciences Po Paris)
• Richard Cantor (Moody's)
• Oliver Everling (Everling Advisory Services http://www.everling.de/ )

• Finance Portal

Leave a Reply