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The Credit Rating Agencies Between Crisis and Resurrection of International Finance Problems and Perspectives. by Giovanni Ferri & Punziana Lacitignola (University of Bari – Italy) [Lezione 10 del corso di Economia delle scelte di portafoglio]
by Giovanni Ferri & Punziana Lacitignola
(University of Bari – Italy)
[Lezione 10 del corso di Economia delle scelte di portafoglio]
Presentation largely drawn on Ferri-Lacitignola Le agenzie di rating tra crisi e rilancio della finanza globale, Bologna, Il Mulino, 2009.
First rating in 1909 by John Moody: US financial markets needed certification after 1907 crisis
To reduce information asymmetries in financial markets, CRAs issue credit ratings on sovereigns, other public entities, banks, corporates and structured finance (SF) products.
The rating is an estimate of the issuer’s ability to honor its future interest and capital payments
For issuers, ratings affectinterest rate spreads (Ederington et al, 1987; Sy, 2002; Gonzalez at al, 2004) & the extent of available investment flows
To the latter extent, it is key whether the rating is investment grade or not (speculativegrade)
Are corporate & SF ratings different? (Violi, 2004)
1931 US Treasury Department: bonds with a rating below investment grade (i.e. below BBB) must be posted with a value below purchasing cost
1936 Banking Act: no holding of below BBB bonds
1975 SEC Regulation 15c3-1 establishes: (i) higher capital requirements for financial firms holding bonds with a rating below BBB; (ii) list of Nationally Recognized Statistical Rating Organizations (NRSROs: Moody’s, S&P, Fitch and, from 2003, Dominion Bond Rating - DBR)
2004 Basel Regulation of bank minimum capital: standard approach hinges on ratings
Moody’s: (founded 1909)
Gross income ($ billion): 1.2 in 2009; 1.19 in 2008; 1.63 in 2007; 0.6 in 2000
Net income ($ million): 402 in 2009; 457 in 2008; 701.5 in 2007; 289 in 2002: 66% from US, 23% from Europe
Over 30,000 rated entities (sovereigns, banks & corporates)
1,700 employees of which 1,000 analysts.
S&P: (founded 1917; in McGraw-Hill group 1966)
In 2008 alone, Standard & Poor's Ratings Services published more than 1,150,000 ratings, including new and revised ratings; 8,500 employees; it covers 70% of global market capitalization.
Fitch: (founded 1913, merged with IBCA in 1997)
Net income (€ million): 350;
3,000 ratings on Sovereigns, Banks & Corporates;
1,200 employees of which 700 analysts.
DBR: (Canada based, NRSRO since 2003)
Other NRSRO agencies: A.M. Best (2005), R&I (2007), JCR (2007), Egan-Jones (2007), LACE (2008), Realpoint (2008)
On GCRAs’ failures, Bhatia (2002) notices that: (i) sovereign ratings result from one-size-fits-all ranking process; (ii) improvement in methodology/disclosure after the EA crisis may wish well for the future
Bissoondoyal-Bheenick (2004): generally, private rating changes have little/no market impact
Bongini et al (2002): stock prices & ratings did not outpace backward looking balance sheet information to assess bank fragility in the EA crisis
Sovereign downgrades follow (rather than lead) currency crises but do better at predicting defaults (Reinhart, 2002; Sy, 2004) → currency instability raises default risk (Reinhart, 2002 but not Sy, 2004); downgrades of structured products done after markets collapsed
A lot of asymmetry in determinants of firm ratings in developed vs. emerging countries: firm specific risk dominates/sovereign risk negligible for developed countries’ firms while the opposite holds for emerging countries information content of firm ratings is much smaller in emerging countries (Ferri & Liu, 2003)
- Sometimes private contracts contain “NRSRO rating triggers” causing adverse consequences, such as the shortening of debt repayment schedules → since the trigger is usually around the investment grade threshold, this may induce the rating agency to be reluctant to downgrade
Johnson (2003): compares downgrading actions by an NRSRO CRA vs. a non-NRSRO CRA at the investment grade threshold, the data suggest the former hesitates (vis-à-vis the latter) to downgrade issuers to speculative grade
Failure at rating structured products is blatant: e.g. Jul 1st - Aug 31st 07 S&P downgraded 1,544 securities guaranteed by resid. mortgages
For extreme chastising views on GCRAs see:
Partnoy (1999): “the reputational capital view of credit rating agencies is not supported by history or economic analysis. Credit rating agencies have not survived for six decades because they produce credible and accurate information. They have not maintained good reputations based on the informational content of their credit ratings. Instead, the credit rating agencies have thrived, profited, and become exceedingly powerful because they have begun selling regulatory licenses, i.e., the right to be in compliance with regulation. Credit ratings therefore are an excellent example of how not to privatize a regulatory function … Never has too little, too late, been so powerful”
White (2001) demands full liberalization dropping NRSRO list
For a more balanced view on GCRAs see Hill (2004):
Rating agencies certainly didn’t do a spectacular job with Enron, but there is considerable evidence that in the normal course, they do a good, if not stellar, job. … The main problems regulatory change could address are those resulting from market concentration. The price of ratings may not be as low, and the quality of ratings may not be as high, as would be the case if the industry were more competitive. But the rating agencies are not completely unconstrained as to price or quality. Potential competition serves as a constraint, as does the specter of increased regulatory scrutiny.
The SEC should permit provisional, location-specific, and industry specific NRSRO designations …
Notwithstanding any efforts the SEC makes … with size and age conferring significant advantages, it’s not easy for a new rating agency to be established or gain a significant presence in the market. Recognizing that the market may still remain quite concentrated, regulatory reform should also encourage rating agencies to be more responsive to the needs of market participants. … creation of a public forum in which market participants would comment on rating agencies’ performance (accountability through voice).
Annual certification by rating agencies that they are operating in accordance with procedures to guard against conflicts of interest.
In light of the shortcomings of the GCRAs & of the fact that they are even less accountable abroad than in the US market, one may ask whether Regional CRAs are needed for capital market development
Answers differ between Europe vs. Asia: while in Europe short-lived national credit rating agencies were sooner or later acquired by the GCRAs, many Asian countries still have their own national credit rating agencies, even if no truly regional agency exists yet
Specifically, Japan has the 2 largest & long lived
How do the Regional CRAs compare to GCRAs?
Japanese CRAs often accused of being too lenient to local issuers with respect to GCRAs, but:
BCBS(2000): Outside of the US, Japanese rating agencies are among the oldest and most active. Data availability has thus attracted the attention of researchers. In this case, analysis has uncovered some fairly large differences between Japanese agencies and non-Japanese agencies, which seem to be tougher on the local issuers. Nevertheless, there may be fewer differences across agencies about relative riskiness, as there is evidence that both Japanese and non-Japanese ratings are highly correlated with market-determined credit spreads.
[This was already pointed out by Kawai (1997), Packer & Reynolds (1997), Packer (2000)]
In recent years, Japanese CRAs have been awarded prizes (over & above GCRAs) by JP Morgan for their work on the Samurai bond market
Shin & Moore (2003): find a systematic bias upward for the two Japanese rating agencies (RAs) and show the bias cannot be explained by keiretsu belonging; however, when they estimate a rating determination equation the discriminating power of the Japanese RAs as measured by the adj R2 is no lower than for Moody's or S&P
Do national companies perceive a difference between GCRAs & Regional CRAs? (JCIF survey, 2001)
University of Bari
By removing exchange rate risks, EMU was a main promoting factor ... but it’s not the only one ...
Asset management seeking diversification and higher return
Better market infrastructure, such as corporate ratings becoming more widespreadFactors behind private bond market development
- Apply a “standardized” rating methodology across countries regardless the environment in which firms operate
NRAs (established since 1985):
Have a comparative advantage to access more appropriate knowledge of local environment (Packer, 2000)
Originated with the support of regulation (Kurosawa, 1999)
Lower fees than those applied by GRAs (JCIF, 2001)
Less independent, most of them are owned by financial institutions (Kurosawa, 1999)Main features of GRAs and NRAs
Specifically for Japanese financial markets:
Markets seem to take into account both NRA and GRA ratings when pricing securities (JCIF, 2001)
By enlarging the number of rated companies, both GRAs and NRAs may actively CONTRIBUTE to FINANCIAL MARKET DEVELOPMENT
Only Asia features a significant presence of NRAs, elsewhere (e.g. EU) NRAs have been acquired by GRAs
Figure 2 Source: Our calculations on Financial Times Interactive data for Winter 2004
Figure 3 Source: Our calculations on Bloomberg data for 2004.
In the rest of the world there are about 60 rating agencies
(tab. 2.1 page 33, Ferri & Lacitignola 2009)
GRAs and NRAs may be complementary and specialize in different clientele.
We investigate this hypothesis using:
Results are depicted in fig. 5
Fig. 5 Source: Our calculations on Bloomberg data between 1990 and may 2005
NRAs: rating smaller-sized companies
Fig. 6 Source: Our calculations on Bloomberg data between 1990 and may 2005
(a) in a La Porta et al. (1997) framework, the presence of NRAs associates with more developed financial markets (in terms of both stock market capitalization and extent of private bond issuance)
(b) focusing on Asia, we identify a specialization pattern whereby NRAs concentrate on rating smaller-sized/domestic-focused companies while GRAs devote themselves to rating larger/more internationalized companies
CRAs claim that ratings are opinions protected by the First Amendment of the US Constitution
Leaving the determination
of CRAs responsability
to Markets, improving
market competition and
removing regulation reliance
Regulate the rating
Independence & accuracy???
Amato & Furfine (2004) Are credit ratings procyclical?, JBF.
Ammer & Packer (2000) How Consistent Are Credit Ratings? A Geographic and Sectoral Analysis of Default Risk, FRB WP 668.
Bhatia (2002) Sovereign Credit Rating Methodology: An Evaluation, IMF WP 170.
BCBS (1999) Supervisory Lessons To Be Drawn From The Asian Crisis, Basel Committee on Banking Supervision WP 2, June.
BCBS (2000) Credit Ratings And Complementary Sources of Credit Quality Information, Basel Committee on Banking Supervision WP 3, August.
Bissoondoyal-Bheenick (2004) Rating timing differences between the two leading agencies: Standard and Poor’s and Moody’s, Emerging Markets Review.
Block & Vaaler (2004) The price of democracy: sovereign risk ratings, bond spreads and political business cycles in developing countries, Journal of International Money and Finance.
Bongini, Laeven & Majnoni (2002) How good is the market at assessing bank fragility? A horse race between different indicators, JBF.
Boot, Milbourn & Schmeits (2004) Credit Ratings as Coordinating Mechanism, July WP.
Burnie & Langsam (2004), How SOX affects investing through credit rating agencies, Journal of Corporate Accounting and Finance.
Cappiello, Hördahl, Kadareja & Manganelli (2006) The impact of the Euro on Financial Markets, ECB wp No. 598.
Carlson & Hale (2004) Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Roll–over, Yale University, mimeo.
Covitz & Harrison (2003) Testing Conflicts of Interest at Bond Ratings Agencies with Market Anticipation: Evidence that Reputation Incentives Dominate, FRB WP 200368.
Dichev & Piotroski (2001) The long-run stock returns following bond ratings changes, Journal of Finance.
Ederington, Yawitz & Roberts (1987) The Informational Content of Bond Ratings”, Journal of Financial Research.
Ferri (2004) More Analysts, Better Ratings: Do Rating Agencies Invest Enough in Less Developed Countries?, Journal of Applied Economics.
Ferri & Lacitignola (2007) Does Europe Need Its Own Rating Agencies?, presented at the XVI International Tor Vergata Conference on Banking and Finance.
Ferri & Liu (2004) Assessing the Effort of Rating Agencies in Emerging Economies: Some Empirical Evidence, European Journal of Finance.
Ferri & Liu (2003) How Do Global Credit Rating Agencies Rate Firms from Developing Countries?,Asian Economic Papers, December.
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Ferri, Liu & Stiglitz (1999) The Procyclical Role of Rating Agencies: Evidence from the East Asian Crisis, Economic Notes, 28, 335-56.
Ferri & Lacitignola (2009) Le agenzie di rating tra crisi e rilancio della Finanza Globale, ed. Il Mulino.
Gonzalez, Haas, Johannes, Persson, Toledo, Violi, Wieland & Zins (2004) Market Dynamics Associated With Credit Ratings A Literature Review, ECB occasional paper.
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Hill (2004) Regulating the Rating Agencies, Washington University Law Quarterly.
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Kliger & Sarig (2000) The Information Value of Bond Ratings, Journal of Finance
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