CORPORATE BOND RATINGS AND AGENCIESAlexandra Leziy-Miller

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Topics and Learning Objectives Debt review Purpose of ratings and users Credit rating agencies Ratings Rating methodology Rating process Controversies

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Corporate Debt Debt

Why does a company take on debt? To undertake projects Mergers and acquisitions Refinance existing debt

What is the big deal about debt? Risk

Borrower Lender

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Purpose of Ratings and Users

Lenders want to know investments are safe

Support judgment Convenience Larger pool of funds Determine the cost of borrowing

Users Investors, Issuers, Regulators

Question?

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Agencies & History The “Big Three”

Standard and Poor’s (S&P) 1860

Moody’s 1900

Fitch Ratings 1913

Nationally Recognized Statistical Rating Organization (NRSRO)

1975

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Standard & Poor’s

1860

Henry Poor &

Railroads

1890

Oil & Steel

1897

Luther Blake

1941

Merger

1957

S&P 500

2011

GlobalMcGraw

Hill Compan

iesTimeline

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Moody’s

1900

John Moody & Industria

ls

1909

Railroads

1914

Moody’s Investor Services

, Inc.

1924Bonds

1970

“Issuer-pays”

2011

Global

Timeline

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Fitch Ratings

1913John Fitch

& Fitch Publishing

Co.

1924Rating Scale

1990s

M&A’sGROWTH

2000M&As

GROWTH

2011Fitch

RatingsFitch

SolutionsFitch

TrainingTimeline

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Long-Term RatingsLong-Term Ratings Moody’

s S&P

Fitch

INVESTMENT GRADEHighest quality Aaa AA

AAAA

High quality (very strong) Aa AA AAUpper medium grade (strong) A A AMedium grade Baa BB

BBBB

NON-INVESTMENT GRADE (Junk Bonds)Lower medium grade (somewhat speculative)

Ba BB BB

Low grade (speculative) B B BPoor quality (may default) Caa CC

CCCC

Most speculative Ca CC CCNo interest being paid or bankruptcy petition filed

C C C

In default C D D

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Short-Term Ratings

Short-Term Ratings

Moody’s S&P Fitch

INVESTMENT GRADEPrime/High

Grade P-1A-1+ F-1+

Upper Medium A-1 F1Low/Upper

MediumP-2 A-2 F2

Lower Medium P-3 A-3 F3NON-INVESTMENT GRADE

Speculative

NOT PRIME

B BExtremely

SpeculativeC C

In Default / /*Short-Term ratings are based on the probability of default within one year

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Main Rating Factors1. Protections afforded in the covenants 2. Collateral3. Ability to make payments

The lower your rating, the more covenants, collateral and requirements your bond issue will contain

To strengthen and reduce risk Credit enhancement

Bond insurance (limited availability) Letter of credit (commercial banks) Third party guarantee (cash, securities, assets)

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Credit Agency Methodology Quantitative and qualitative analyses

Event risk Natural disaster – e.g. Florida vs. Wyoming

Financial risk – Ability to make payments Company vs. company comparison Microeconomic event Ratios

Business risk Industry vs. industry comparison – e.g. oil vs. airline Economy - macroeconomic event

Corporate governance risk Ownership structure Management quality

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The Ratings Process1. Submit application (request rating)2. Lead analyst and team3. Review committee4. Inform issuer5. Appeal6. Public7. Monitor

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Monitoring Why is monitoring of ratings important?

Cost of borrowing Regulations Credit watch & outlook

(positive/stable/negative) Does not necessarily lead to a change Current Events: April 18, 2011

AAA Rating On United States of America ; Outlook Revised To Negative

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Controversies Conflict of interest

“Investor-pays” business model “Issuer-pays” business model

Ratings don’t change quickly enough Enron

Barriers to entry High

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Market Share

S&P; 40%

Moody's; 40%

Fitch; 15%Other; 5%

Market Share

S&PMoody'sFitchOther

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Questions? Thank you

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References Standard and Poor’s

http://www.standardandpoors.com Moody’s

http://www.moodys.com Fitch:

http://www.fitchibca.com U.S. Securities and Exchange Commission (SEC)

http://www.sec.gov WIKIPEDIA

http://en.wikipedia.org/wiki/Credit_rating_agency Fabozzi, Modigliani, Jones (2010). Foundations of Financial

Markets and Institutions, 4th ed. Pearson Education, Inc.