9780470018002

The Rating Agencies and Their Credit Ratings What They Are, How They Work, and Why They are Relevant

by ;
  • ISBN13:

    9780470018002

  • ISBN10:

    0470018003

  • Edition: 1st
  • Format: Hardcover
  • Copyright: 3/2/2009
  • Publisher: Wiley
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Summary

Credit rating agencies play a critical role in capital markets, guiding the asset allocation of institutional investors as private capital moves freely around the world in search of the best trade-off between risk and return. However, they have also been strongly criticised for failing to spot the Asian crisis in the early 1990s, the Enron, WorldCom and Parmalat collapses in the early 2000s and finally for their ratings of subprime-related structured finance instruments and their role in the current financial crisis.This book is a guide to ratings, the ratings industry and the mechanics and economics of obtaining a rating. It sheds light on the role that the agencies play in the international financial markets. It avoids the sensationalist approach often associated with studies of rating scandals and the financial crisis, and instead provides an objective and critical analysis of the business of ratings. The book will be of practical use to any individual who has to deal with ratings and the ratings industry in their day-to-day job.Reviews"Rating agencies fulfil an important role in the capital markets, but given their power, they are frequently the object of criticism. Some of it is justified but most of it portrays a lack of understanding of their business. In their book The Rating Agencies and their Credit Ratings, Herwig and Patricia Langohr provide an excellent economic background to the role of rating agencies and also a thorough understanding of their business and the problems they face. I recommend this book to all those who have an interest in this somewhat arcane but extremely important area." -Robin Monro-Davies, Former CEO, Fitch Ratings."At a time of unprecedented public and political scrutiny of the effectiveness and indeed the basic business model of the Credit Rating industry, and heightened concerns regarding the transparency and accountability of the leading agencies, this book provides a commendably comprehensive overview, and should provide invaluable assistance in the ongoing debate." -Rupert Atkinson, Managing Director, Head of Credit Advisory Group, Morgan Stanley and member of the SIFMA Rating Agency Task Force"The Langohrs have provided useful information in a field where one frequently finds only opinions or misconceptions. They supply a firm base from which to understand changes now underway. A well-read copy of this monograph should be close to the desk of every investor, issuer and financial regulator, legislator or commentator." -John Grout, Policy and Technical Director, The Association of Corporate Treasurers

Author Biography

The rating agencies and their credit ratings

"At a time of unprecedented public and political scrutiny of the effectiveness and indeed the basic business model of the Credit Rating industry, and heightened concerns regarding the transparency and accountability of the leading agencies, this book provides a commendably comprehensive overview, and should provide invaluable assistance in the ongoing debate."

—Rupert Atkinson, Managing Director, Head of Credit Advisory Group, and member of the SIFMA Rating Agency Task Force

“The Langhors have provided useful information in a field where one frequently finds only opinions or misconceptions. They supply a firm base from which to understand changes now underway. A well-read copy of this monograph should be close to the desk of every investor, issuer and financial regulator, legislator or commentator.”

—John Grout, Policy and Technical Director, The Association of Corporate Treasurers

Table of Contents

Forewordp. ix
Prefacep. xiii
Introductionp. 1
Context and Premisesp. 1
The Benchmarking of Default Prospects Remains Deeply Rooted in Business Analysisp. 1
Credit Ratings Play a Unique Role in Overcoming Information Asymmetries on the Information Exchangesp. 9
Under the Spotlight as Unique Infomediaries, the CRAs became Strictly Regulatedp. 13
Book Chaptersp. 17
Supporting Materialsp. 18
Credit Rating Foundationsp. 21
Credit Ratingsp. 23
The World of Corporate Defaultsp. 24
What are Corporate Defaultsp. 27
The Drivers of Corporate Defaultsp. 35
Recovery Rates from Defaultsp. 39
Credit Rating Scalesp. 40
Fundamental Ordinal Credit Rating Scalesp. 43
Rating Scales and Observed Bond Market Credit Spreadsp. 64
Market-Implied Cardinal Rating Scales and Default Probabilitiesp. 72
The Interpretation of Credit Ratingsp. 74
Interpreting from the Scalep. 75
Correctly Interpreting versus Misinterpreting Ratingsp. 78
Special Issuesp. 85
Credit Ratings: Summary and Conclusionsp. 88
The Raison d'Etre of Credit Ratings and their Marketp. 89
Needs for Credit Ratings - or the Demand Side of Ratingsp. 89
Principals: Issuers/Borrowersp. 91
Principals: Fixed Income Investorsp. 99
Prescribersp. 104
Credit Ratings as a Solution to Information Asymmetry: Economic Analysisp. 111
Economics of Ratings: Intuitionp. 111
Economics of Ratings: Analysisp. 113
The Economic Analysis of Ratings: Summary and Implicationsp. 124
Credit Rating Segments - or Scale and Scope of the Rated Universep. 126
Industry Segments or Type of Rated Issuersp. 126
Product Segments or Types of Rated Issuesp. 138
Geographical Segments or Location of the Obligorp. 149
Summaryp. 158
Technical Appendixp. 158
How to Obtain and Maintain a Credit Ratingp. 161
The Rating Preparationp. 161
The Issuer Clientp. 163
The Rating Adviser-Intermediaryp. 165
The Credit Rating Agency Supplierp. 168
The Ratingp. 170
The Rating Actionp. 170
Rating Follow-Upp. 174
The Rating Agreementp. 179
Quality of the Rating Processp. 187
Objectivityp. 188
Diligencep. 189
Transparencyp. 191
Credit Rating Analysisp. 195
The France Telecom Credit Rating Cycle: 1995-2004p. 197
From Sovereign Status to Near Speculative Grade (1995-2002)p. 198
How Sovereign Aaa Status of June 1995 Adjusts to Corporate Aa1 in July 1996p. 198
A Company that went Public on Aa1 Status in October 1997 is Downgraded to Aa2 in December 1999p. 200
Rapid Extension of FT's Reach and Two Notches Downgrade to A1 in September 2000p. 202
A Wake-up Call: the Orange IPO and Surprise Two Notches Down-grade to A3 in February 2001p. 211
The Slide Downward to Baa1 in September 2001p. 219
Looming Crisis and Two Notches Downgrade to Baa3 in June 2002p. 222
Turning Point and Rating Recovery (Fall 2002-Winter 2004)p. 229
Improvement in Outlook in September 2002p. 229
A New Start in October 2002 and Recovery Actionsp. 238
Recovery Implementation and the Sequence of Rating Upgrades through February 2005p. 244
Analysis and Evaluationp. 247
Risk Shifting at France Telecom and its Fundamental and Market-Implied Ratingsp. 248
The Restraint of the CRAs during the 2002 Crisisp. 253
The Value of Ratings to Issuersp. 254
Credit Rating Analysisp. 257
Fundamental Corporate Credit Ratingsp. 257
Corporate Credit Risk2p. 257
Credit Risk of Corporate Debt Instrumentsp. 260
Putting it All Together: the Rating8p. 265
Corporate Ratings Implied by Market Datap. 274
The Conceptp. 274
Mechanics of Extracting Default Probabilities from Market Prices21p. 276
Market-Implied Ratingsp. 284
Special Sector Ratingsp. 286
Sovereign Ratingsp. 286
Financial Strength Ratingsp. 291
Structured Finance Instruments Ratingsp. 296
Technical Appendixp. 304
Step 1: Computing the Implied Market Value of Assets and Asset Volatilityp. 305
Step 2: Computing the Distance to Defaultp. 305
Step 3: Calculating the Default Probability Corresponding to the Distance to Defaultp. 306
Credit Rating Performancep. 307
Relevance: Ratings and Valuep. 307
Structural Relevance: Rating and Credit Spreadsp. 310
Impact Relevance: Rating Actions and Security Price Changesp. 325
Evaluation: How Relevant are Fundamental Credit Ratings?p. 331
Preventing Surprise in Defaults: Rating Accuracy and Stabilityp. 332
Metrics of Accuracy and Stabilityp. 334
Analysis of the Prevention of Surprise in Defaultsp. 353
Summary, Evaluation and Conclusionp. 356
Efficiency Enhancement: Stabilization in Times of Crisis?p. 356
The Asian Macroeconomic Financial Crisisp. 356
The Western Microeconomic Equity Crisisp. 363
The Subprime Mortgage Related Crisisp. 364
Criticisms: the Ratings in Crisis?p. 369
The Credit Rating Businessp. 373
The Credit Rating Industryp. 375
The Rise of the Credit Rating Agenciesp. 375
Originsp. 375
Macroeconomic Forces Shaping the Current Industryp. 378
The Current Structure of the Industryp. 384
Industry Specifics and How They Affect Competitionp. 407
Agencies Compete for the Market rather than in the Marketp. 407
The Business Model and Profit Driversp. 411
Some Dynamic Aspects of Competition among CRAs: A Small Number of Players can be Consistent with Intense Rivalryp. 418
Industry Performancep. 419
Performance for CRA Shareholdersp. 419
Performance of Ratings as a Public Goodp. 420
Performance for Issuersp. 427
Performance for Investorsp. 427
Conclusionp. 428
Regulatory Oversight of the Credit Rating Industryp. 429
The Regulatory Uses of Ratingsp. 430
Prudencep. 435
Market Accessp. 436
Investor Protectionp. 439
The Regulation of the Industryp. 440
The Regulatory Optionsp. 440
Worldwide Regulatory Initiative: the 2004 IOSCO Code of Conductp. 443
The 2005 European Union Policy on Credit Rating Agenciesp. 444
The US 'Credit Rating Agency Reform Act of 2006'p. 448
Analysis and Evaluationp. 455
The EU and the US Approaches Comparedp. 455
The Positions of the Main Stakeholdersp. 461
Comments and Evaluation on Regulatory Optionsp. 466
Summary and Conclusionsp. 469
The Challenges Facing Rating Agencies Todayp. 469
From Regulatory Legitimacy to Market Legitimacyp. 469
Financial Innovationp. 472
Growth and Globalizationp. 473
Conclusionp. 473
Referencesp. 475
Indexp. 495
Table of Contents provided by Ingram. All Rights Reserved.

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