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A Matter of Opinion
Standard & Poors ratings opinions are based on analysis by experienced professionals who evaluate and interpret information received from issuers and other available sources. Unlike other types of opinions, such as, for example, those provided by doctors or lawyers, credit rating opinions are not intended to be a prognosis or recommendation. Instead, they are primarily intended to provide investors and market participants with information about the relative credit risk of issuers and individual debt issues that the agency rates. Standard & Poors public ratings opinions are also disseminated broadly and free of charge to recipients all over the world on www.standardandpoors.com
Credit Ratings Are Intended To Be Comparable Across Different Sectors and Regions
Standard & Poors uses the same rating scale across the structured finance, corporate, and government sectors. This rating scale is designed to provide a common language for comparing creditworthiness, regardless of the type of entity or assets underlying the debt instrument or the structure of the financial obligation. This approach is in keeping with Standard & Poors goal of providing credit ratings that are reasonably comparable measures of credit quality. This means, for example, in assigning A ratings to asset-backed securities, manufacturing firms, or local governments, Standard & Poors intends to connote an opinion that they have a comparable level of credit risk. Standard & Poors believes that, over the long term, comparable credit opinions are likely to result in reasonably
similar average default rates for each rating category across sectors, regions and asset classes. However, as demonstrated in historical studies, default rates in each rating category can fluctuate and such fluctuations are to be expected in the future.
Some major differences among rating agencies, which are explored in the following sections of this module, include: The methodologies/approaches they use in assessing risk Their scope of coverage The business models under which they operate Some credit rating agencies, including major global agencies like Standard & Poors, are publishing and information companies that evaluate the credit risk of issuers and individual debt issues. They formulate and disseminate their opinions for use by investors and other market participants who may consider credit risk in making their investment and business decisions. Partly because rating agencies are not directly involved in capital market transactions, they have come to be viewed by both investors and issuers as impartial, independent providers of opinions on credit risk. While investors and other market participants are also capable of analyzing credit quality, rating agencies can generally perform credit analyses more efficiently and economically than other firms because they specialize in that activity and devote substantial resources to it.
qualitative information, such as long-term strategies, as they assess the issuers ability and willingness to meet its financial obligations in a timely manner. Rating agencies that use the analyst-driven approach often employ analysts with experience in evaluating the relative credit risk of an entity or security. In addition to their experience with and understanding of the credit markets, analysts are trained to think critically and to evaluate complex business, financial, and accounting issues. Many analysts also bring to bear specializations in specific industry segments and transaction structures in evaluating credit risks attributes. Model-Driven Credit Ratings A small number of rating agencies use the model-driven approach, focusing more exclusively on quantitative data that they incorporate into a mathematical model to produce their ratings, which are generally point-in-time assessments. For example, an agency using this approach to assess the creditworthiness of a bank or financial institution evaluates that entitys asset quality, funding, and profitability based on figures that appear in that entitys financial statements and regulatory filings. The mathematical formulas used to measure creditworthiness are often proprietary and highly complex.
rating agencies may also offer country-specific scales in addition to their global scale ratings, as Standard & Poors does.
2008
Opened offices in Dubai, South Africa, and Israel (through the acquisition of Maalot)
Investors
Investors most often use credit ratings to help assess credit risk and to compare different issuers and debt issues when making investment decisions and managing their portfolios.
Individual investors, for example, may use credit ratings in evaluating the purchase of a municipal or corporate bond from a risk tolerance perspective. Institutional investors, including mutual funds, pension funds, banks, and insurance companies often use credit ratings to supplement their own credit analysis of specific debt issues. In addition, institutional investors may use credit ratings to establish thresholds for credit risk and investment guidelines. A rating may be used as an indication of credit quality, but investors should consider a variety of factors, including their own analysis.
Intermediaries
Investment bankers help to facilitate the flow of capital from investors to issuers. They may use credit ratings to benchmark the relative credit risk of different debt issues, as well as to set the initial pricing for individual debt issues they structure, and to help determine the interest rate these issues will pay. Investment bankers and entities that structure special types of debt issues may look to a rating agencys criteria when making their own decisions about how to configure different debt issues, or different tiers of debt. Investment bankers may also serve as arrangers of special debt issues. In this capacity, they establish special entities that package assets, such as retail mortgages and student loans, into securities, or structured finance instruments, which they then market to investors.
Issuers
Issuers, including corporations, financial institutions, national governments, states, and cities and municipalities, use credit ratings to provide independent views of their creditworthiness and the credit quality of their debt issues. Issuers may also use credit ratings to help communicate the relative credit quality of debt issues, thereby expanding the universe of investors. In addition, credit ratings may help issuers anticipate the interest rate to be offered on their new debt issues. As a general rule, the more creditworthy an issuer or an issue is, the lower the interest rate the issuer would typically have to pay to attract investors. The reverse is also true: an issuer with lower creditworthiness will typically pay a higher interest rate to offset the greater credit risk assumed by investors.
Standard & Poors uses AAA, BB, or CC to communicate relative credit risk, with AAA denoting the strongest creditworthiness and C or D denoting the weakest, or that a default has occurred. The rating symbols provide a simple way to communicate opinions about creditworthiness. While a rating scale itself is relatively straightforwardfor example, a bond rated AAA signals higher credit quality than a bond rated BBthe assumptions, considerations, and judgments that help to form a rating opinion are different and complex. This complexity results in part from different types of risk factors informing the analysis that range, for example, from a particular issuers financial performance and the competitive environment in which it operates to the structure or details of a particular issue. In addition, the rating process factors in events that may occur in the foreseeable future and are likely to affect the credit risk of a particular issuer or issue. Over time, the overall performance of Standard & Poors ratings has helped to establish its rating scale as a good benchmark of relative credit risk. This in turn, has enabled investors and market participants to use ratings as a benchmark and as a second opinion when performing their own analysis. Standard & Poors typically expresses its opinion of creditworthiness in terms of three components: The long-term rating The outlook on the long-term rating The short-term rating, where applicable
Ratings Definitions
View the complete list of Standard & Poors Ratings Definitions and a related article on Understanding Standard &
View the complete list of Standard & Poors Ratings Definitions and a related article on Understanding Standard & Poors Ratings Definitions
Recovery Ratings
Some credit rating agencies also incorporate into their ratings opinions the potential for recovery, which is an opinion about the amount that investors may recover in the event of default. Rating agencies that assess recovery consider the percentage of the instruments outstanding principal that an investor can expect to receive back. When used as a rating factor, recovery prospects are an important component in evaluating credit quality, particularly in the evaluation of non-investment-grade debt. To address the markets need for recovery information, Standard & Poors began assigning recovery ratings in 2003 and the use of these ratings continues to evolve. As of 2008, such recovery ratings were assigned by Standard & Poors to secured and unsecured debt of speculative-grade corporate issuers in the U.S., Western Europe, and certain other countries. These ratings provide a forward-looking analysis based on issuer-specific and deal-specific data, and express Standard & Poors opinion regarding prospective loss on debt issues in the event of default. Risk factors include how the debt is structured, the relationship among creditors, the jurisdiction, and how a default would affect the value of the assets. Standard & Poors recovery ratings use a scale of 1 to 6 rather than the letter ratings and express an opinion about the percentage of principal and unpaid accrued interest that investors may expect to receive in the case of default. The opinion is based on a number of different factors, including the rights that investors and/or creditors may have to specific assets, the potential liquidation value of the entitys assets, and the result of formal bankruptcy proceedings or informal out-of-court restructuring. The recoveries themselves may be in cash, debt, or equity securities of a reorganized entity, or some combination of the three. The recovery rating scale forms the basis for adjusting the credit rating of an issue up or down relative to the credit rating of the issuer.
Standard & Poors rating process is generally similar for all issuers, including corporations, governments, and financial institutions, though there are some differences, including with respect to rating structured finance instruments. These differences involve the way the process is initiated and conducted, the rating criteria and assumptions that apply, as well as the specific kinds of information that analysts review, particularly the details of the debt issue itself, which are further discussed within this section. Rating an Issuer To assess the creditworthiness of a corporate or government issuer, Standard & Poors concentrates on the attributes evidencing the issuers ability and willingness to repay its obligations in full and in accordance with their terms. To form that opinion, agency analysts weigh a broad range of business and financial attributes relevant to that issuer that may influence the issuers ability to repay. For example, credit rating analysis of a corporate issuer typically considers many financial and non financial factors, both qualitative and quantitative. These include, to name only a few: economic, regulatory, and geopolitical influences; management and corporate governance attributes; key performance indicators; competitive trends; product-mix considerations; R&D prospects; patents rights; and labor relations. Standard & Poors uses interactive, qualitative analysis and its analysts typically engage in a dialogue with the issuers management to obtain additional information and insight about the issuers current position and future plans. In most cases, once Standard & Poors has rated an issuer, it tracks, or conducts surveillance of, that issuer over time. Standard & Poors may adjust the issuers rating if the issuers credit risk profile changes in key risk factors, such as market conditions, business prospects and capitalization. Rating an Issue In rating an individual issue, Standard & Poors evaluates its credit quality and likelihood of default based on current information furnished by the issuer or obtained from other reliable sources. Key considerations include: The issues terms and conditions and, if relevant, its unique legal structure Relative seniority of the issue with regard to the issuers other debts and priority of repayment in the event of default The existence of external support or credit enhancements (including mechanisms such as letters of credit, guarantees, insurance, and collateral, which are protections designed to limit the potential credit risks associated with a particular issue. Enhancements are a key factor in analyzing structured finance instruments). In the case of corporate and government issues, the process typically begins with an evaluation of the creditworthiness of the issuer before assessing the details and credit quality of a specific issue. Rating Structured Finance Instruments With most structured finance instruments, the issuers are special-purpose entities (SPEs) which are created solely to accumulate and finance pools of assets by selling securities to investors. In forming its opinion of a structured finance instrument, Standard & Poors evaluates, among other things, the potential risks posed by the instruments legal structure, the credit quality of the assets the SPE holds, and the anticipated cash flow of these underlying assets, as well as credit enhancements that provide added protection against default to some or all of the securities. For more information see Process For Rating Structured Finance Instruments
entity, including those securities issued in different countries. For various reasons, including guarantees, insurance, prospects for recovery, etc., Standard & Poors may rate an issue higher or lower than the rating assigned to the issuer itself. Standard & Poors Public Finance Ratings Group, typically issues ratings that are issue-specific (e.g., general obligation notes, revenue bonds, school district bonds, or bonds to fund projects), as opposed to ICRs.
The Initial Rating Process The initial rating process for corporate, government, and financial entities typically takes four to six weeks to complete, but can run longer or shorter. This initial process begins when the contract is signed and generally ends with the publication of the rating. The rating process consists of several discrete steps, as shown in Standard & Poors Typical Process For a New Corporate or Government Rating and typically includes a series of ongoing information exchanges between the rating agency and the issuer. These interactions enable Standard & Poors to gather the information it needs to conduct its evaluation and form its rating opinion. The Analytical Team & Rating Committee Standard & Poors assigns a lead analyst and generally a backup analyst to begin the rating process. Standard & Poors selects the analysts for each rating assignment based on their knowledge of and experience with a particular issuer, sector, industry, or the type of debt obligation being issued. To strengthen the evaluation process, Standard & Poors appoints a committee of generally five members, including the lead and backup analysts. The role of the committee is to review and assess the lead analysts rating recommendation for a new rating or a ratings change, to provide additional perspectives in the analysis, to provide checks and balances against conflicts and undue influence, and to provide consistent application and adherence to the ratings criteria. For repeat issuances, outlook changes, CreditWatch placements and certain other instances, the committee may be smaller, but an individual analyst can never make such a ratings decision on his or her own. Committee members are chosen for their particular areas of expertise, which might include, for example, accounting or risk management. If the issuer is an international corporation, the committee may include analysts who are familiar with the regions and markets in which the issuer operates. In addition, Standard & Poors appoints a committee chairperson who is responsible for overseeing the committee process and making sure that the relevant criteria are applied consistently. Pre evaluation. Prior to meeting with the issuers management, the analysts examine the issuers publicly
reported financial information and any other relevant information provided by the issuer. This pre evaluation helps analysts identify and define additional information needed from the issuer as well as specific matters the issuer should be prepared to address at the management meeting. Management meeting. The purpose of the management meeting, which is generally attended by the issuers relevant senior executives, is to enable Standard & Poors analysts to probe pertinent information in greater detail, including public information as well as other information that may be provided by the issuer. The discussion usually takes place in person at the issuers offices, but in some cases can take place at Standard & Poors offices, over the phone, or a combination of all of these. At the conclusion of the meeting, Standard & Poors will outline the committee process and provide an indication as to how long the process may take. However, the meeting may result in a request for clarification, for additional information, or for continuing dialogue. Analysis. For corporate and government ratings, analysts typically begin their evaluation by assessing the business and financial risk profiles of the issuing entity (as summarized within the Key Analytical Considerations table below). Analysts also consider comparisons to similar entities, as such comparisons help inform the analysts views of the entity in relation to its peers. In evaluating the financial profile of a corporate or financial entity, for example, Standard & Poors analysts may first examine the companys financial statements, including an evaluation of its accounting practices, focusing on any unusual treatments or underlying assumptions. To further assess a corporations overall strengths and weaknesses, the analysts use a number of financial ratios, including those that evaluate profit margins, leverage, and cash flow sufficiency. Analysts may also take into account items that do not appear on a corporations balance sheet, such as leases and pension liabilities that can have an impact on the companys creditworthiness. In many cases, financial risk factors that are unique to a specific type of issuer or issue play an important role in financial analysis. For example, in analyzing the capital adequacy of international financial institutions, Standard & Poors may make adjustments to the issuers reported assets to incorporate Standard & Poors view of risk levels for each of the issuers distinct business lines and for the specific regions the issuer operates within. In evaluating a government entity, analysts use essentially the same process, though the specific risk factors they consider differ slightly. For example, analysts focus on the economic base rather than business risk, as well as on any potential instabilities or political pressures that may affect the entitys creditworthiness. Committee evaluation. The lead analyst presents his or her assessment to the committee, which discusses, questions, and debates the analysts conclusions and evaluation of certain risk factors. The final rating assigned by the committee is primarily determined by applying the rating criteria to the information that the analysts have collected and evaluated. However, rather than providing a strictly formulaic assessment, Standard & Poors factors into its ratings the perceptions and insights of its analysts based on their consideration of all of the information they have obtained. This process helps the committee to form its opinion of an issuers overall ability to repay obligations in accordance with their terms. The committee reviews and discusses the internal report presented by the lead analyst. This internal document summarizes the main analytical factors and outlines the rationale for the long-term rating, outlook, and short-term rating for a specific issuer. The committee analyzes each subcategory of credit risk, such as an entitys business and financial risk profiles, and comments on particular strengths and weaknesses that affect the entitys rating. The final report summarizes the main expectations that were factored into the rating and notes the conditions that might lower or raise the rating in the future. Notification of issuer. Standard & Poors generally notifies the issuer of the rating and outlook, and provides a rationale for the major factors supporting the rating. If an issuer disagrees with the rating conclusion, Standard & Poors may allow for an appeal only if the issuer can provide new and significant information to support its point of view. If an appeal is granted, Standard & Poors will reconvene the committee, review the new information, and vote again on the rating.
Publication. For public ratings, in most cases, Standard & Poors publishes a press release announcing the final rating along with the rationale, distributes it to the media, and posts it on www.standardandpoors.com. To verify that the factual information is correct and that no confidential information has inadvertently been disclosed, Standard & Poors may provide the issuer with a copy of its report for a review prior to releasing it to the public. However, if the rating is provided on a confidential basis, the rating is not published and Standard & Poors disseminates the rating only to the rated entity. Key Analytical Considerations In rating corporate, government, and financial entities and issues, Standard & Poors evaluates a broad range of business, financial, and entity-specific risk factors to develop the clearest and most comprehensive assessment of that entitys creditworthiness. The following table summarizes the key analytical factors that go into determining those ratings:
Ratings Type
Issuer Ratings Current opinion of an entitys overall creditworthinessits ability and willingness to repay its financial obligations Credit risk assessment of issuer as a whole, but not of a specific debt issue
Issue Ratings Opinion of the credit quality of a specific financial obligation and issuers willingness and capacity to pay in accordance with term
For Corporate and Government Issues Credit risk of the issuer The terms and conditions of the debt security and, if relevant, its legal structure The relative seniority of the issue with regard to the issuers other debt issues and priority of repayment in the event of default The existence of external support or credit enhancements, such as letters of credit, guarantees, insurance, and collateral. These protections can provide a cushion that limits the potential credit risks associated with a particular issue
Collateral analysis Cash flow analysis Review of legal socuments Rating committee recommendation There are specific points at the conclusion of the above noted analytical steps at which the Primary Analysts will provide feedback to the originator or arranger on the results of the analytical reviews. At these points, the originator or arranger may decide to (a) move forward, (b) reconfigure the collateral pool or terms of the transaction and ask for a review of the alternative structure, or (c) decide to cancel the transaction. As noted above: Standard & Poors may decide not to move forward with the rating if it believes there is not sufficient or reliable information on which to form an opinion of the credit quality of the assets, or if the structure is not well defined. Standard & Poors ratings analysts do not structure transactions and do not tell an arranger what it should or should not do. Rating Committees. The primary analyst forms an initial opinion as to the credit quality of the instruments and recommends the proposed ratings in a meeting with the rating committee. The rating committee, notification and publishing processes are generally the same for structured finance as they are for rating corporate and government entities as described on this site [Typical Process For A New Corporate Or Government Rating]. However, in cases of public ratings, where a presale report is published, Standard & Poors may hold two rating committees. If a preliminary rating committee is held, a preliminary rating will be voted on and published along with a presale report. Even if a preliminary rating committee is held, the final rating is determined by a Final Rating Committee. As with corporate and government ratings, an internal report is prepared that serves as the basis of the rating recommendation for the rating committees decision.
The process of stratifying a pool of undifferentiated risk into multiple classes of debt instruments with varying levels of seniority is called tranching. Investors who purchase the senior tranche, with the highest quality debt and typically the lowest interest rate, are generally repaid first from the cash flow of the underlying assets. Holders of the next-lower tranche, which would typically pay a somewhat higher rate, are paid second, and so forth. Investors who purchase the lowest tranche ordinarily have the potential to earn the highest interest rate the transaction offers, but they also assume the highest risk. Many structured finance transactions incorporate credit enhancements, which are committed resources that can make up for, or cushion, shortfalls in principal and interest receipts on the underlying assets. Credit enhancements are typically in the form of external support and/or internal enhancements, such as insurance or over collateralization.
Ratings Type
Structured Finance Ratings (on Cash Flow Securities) Opinion of credit quality of a structured finance instrument Issuer is typically a limited or special-purpose entity (SPE) Creditworthiness is limited to the capacity to repay securities from the cash flow generated by or
Cash flow expected to be generated by the underlying assets Variability of the future performance of the underlying assets Additionally committed resources that can make up for, or cushion, shortfalls in principal and
liquidation of the underlying assets and committed sources Also considers guarantors, insurers, or other forms of credit enhancement Ratings are typically provided for each tranche issued in a transaction, depending on overall structure of the transaction
interest receipts on the underlying assets, typically in the form of external support and/or internal credit enhancements, such as insurance or over collateralization Practices, policies, and procedures of originators and servicers Legal structure of the securities issued, including payment and servicing structure, and documentation related to creation of the issuing special purpose entity (SPE)
Note: The above addresses the most common structured finance instruments. Standard & Poors also provides ratings on other types of structured finance instruments. For more information on the related criteria, please refer to the Criteria & methodologies section of Standard & Poors public web site
coming 6 to 24 months. Placing ratings on CreditWatch. This occurs when there is a one-in-two likelihood of a rating change in the near term as a result of an event, a significant and unexpected deviation from anticipated performance, or a change in criteria has been adopted that necessitates a review of an entire sector or multiple issues. Raising or lowering a rating. Standard & Poors discloses changes to public ratings, generally with a short explanation, and makes them available at www.standardandpoors.com. Actions may include credit rating upgrades, downgrades, withdrawals, and suspensions, as well as changes in credit rating outlooks and CreditWatch placements and removals. Type and Frequency of Surveillance Standard & Poors considers a number of different factors in determining the type of surveillance to perform on a particular rating. For example, the frequency and extent of surveillance may depend on specific risk considerations that are relevant to an individual, a group, or a class of rated entities. In addition, the regularity of surveillance may be related to the timing and availability of financial and regulatory reporting, transaction-specific performance information, and other new information from various sources. For corporate and government ratings, it is routine to schedule periodic meetings with management. These faceto-face meetings with issuers assist analysts in staying apprised of any changes in the issuers plans and allow them to discuss new developments, performance relative to prior expectations, and potential problem areas. For structured finance ratings, dedicated surveillance analysts monitor performance data and other pertinent information.
developments, or criteria changes may trigger a CreditWatch listing. While the listing means that the potential for a rating change is substantial in the near term, it does not mean that a ratings change is inevitable. Rather, it indicates that more information or analysis is required before taking action. Whenever possible, the rationale explaining the CreditWatch placement indicates a range of possible ratings outcomes that can be anticipated, particularly the extent of the change, up or down. Standard & Poors may also adjust a credit rating without placing the issuer or issue on CreditWatch beforehand. Standard & Poors does not delay a ratings change merely because it has not signaled a potential change on CreditWatch. If all the necessary information is available, Standard & Poors changes the rating to reflect the altered circumstances.
mergers and acquisitions, or an increase or decrease in projected revenues. While some risk factors tend to affect all issuers, others may pertain only to a narrow group of issuers and issues. For instance: A securitized obligation based on underlying credit card payments may have geographically concentrated portfolios, exposing it to regional slumps that a more diversified pool would dilute. The creditworthiness of a government issuer may be affected by changes in the stability of political and economic institutions within its country. In the case of corporate issuers that adopt a highly aggressive business model, such as growth through large acquisitions or expansion in unproven markets, the risks associated with their ability to execute this strategy are important factors in assessing their creditworthiness. Ratings Volatility Volatility of ratings can be expressed either as the proportion of ratings that change or the frequency of change. Higher ratings, in general, have been more stable than lower ratings. Standard & Poors upgraded or downgraded roughly 20% of its corporate credit ratings each year from 1981 through 2007, compared to about 10% for structured finance from 1978 through 2007. However, these percentages can increase during periods of significant and unexpected changes in the credit markets or the business environment. In addition, credit ratings for a specific industry, or for a type of structured finance instrument, can have higher or lower rates of change than the general averages. For example, when the price of oil declined sharply in the mid-1980s, Standard & Poors lowered its ratings on about 75% of rated companies in the oil industry, and some of the ratings were lowered repeatedly. Merger and acquisition activity at the time also weakened credit quality. In 1986, the oil industrys default rate reached 9.3% of rated companies in the industry. Declining credit quality eventually spread to Texas banks that made loans to energy companies, which led to above-average downgrades for financial institutions within the region. Ratings Withdrawals Standard & Poors may withdraw a credit rating at any time. For example, it may withdraw issuer credit ratings when there is not enough information to actively monitor the rating. It also withdraws the ratings on issues that have been repaid in full. In rare cases, credit ratings may also be withdrawn at the request of an issuer, such as when a company has been acquired. In some of these cases, Standard & Poors may temporarily suspend rather than withdraw a credit rating if there is an expectation that adequate information will become available and/or the rating is likely to be reinstated. Prior to withdrawing or suspending the rating, Standard & Poors will affirm, downgrade, or upgrade the rating. Ratings Changes and Structured Finance Historically, structured finance ratings have been relatively stable in comparison to corporate ratings. Yet structured ratings are also subject to circumstances that can result in greater ratings volatility than is typically the norm. This volatility may affect the markets generally, or only certain asset classes. Ratings changes are generally driven by changes in the credit performance of the underlying assets which back the structured finance instruments. For example, a structured finance vehicle may sell notes worth $100 million and receive an investment-grade rating because there is overcollateralization or a cushion of an additional $15 million in assets in the vehicle. This overcollateralization or credit enhancement raises the total value of the asset pool to $115 million, with the additional collateral providing a buffer against future adverse conditions. But if the conditions are worse than anticipated, and the underlying assets generate less cash flow than expected, the shortfall will reduce the buffer created by the additional $15 million. As a result, Standard & Poors could lower its rating on the related structured finance instruments to reflect the decrease in credit quality of the underlying assets in the pool.
and volatility of credit ratings. For example, investors who are obligated to purchase only highly rated securities and are looking for some indication of stability may review the history of rating transitions and defaults as part of their investment research. In addition to its studies of three broad market segmentscorporate, government, and structured finance Standard & Poors publishes narrower transition and default studies. For example, these studies track local and regional governments separately from national governments and analyze corporate issuers based on their industry classification. The studies also distinguish among different types of structured finance instruments, such as residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs). Standard & Poors begins tracking its own ratings as soon as they are initially assigned. Analyzing transition and default rates by vintage, which is the year in which Standard & Poors first rates an issue or issuer, has yielded a number of important findings: Higher Credit Ratings Correlate Positively with Lower Default Rates Standard & Poors transition and default studies support the relationship between higher ratings and lower default rates in each of the three broad market segments. In other words, default rates tend to rise with each step down the rating scale. In addition, studies show that what market participants generally refer to as investment grade ratings (BBB and above) are associated with lower default rates than non-investment grade ratings (below BBB). Lower Ratings Are Less Stable Than Higher Ratings Ratings performance data show that lower ratings are less stable than higher ratings. This means a higher proportion of A-rated issuers and issues retain their A rating during a specified time period, compared with a smaller portion of B-rated issuers and issues for that same period. Ratings Are More Volatile Over Time Ratings are more volatile over longer time periods. For example, regardless of category, transition rates over a 10 year period show greater volatility than one-year transition rates. The broader range of business conditions that can affect credit quality over the course of a longer period may partly account for this increased volatility.
Further Reading
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Some have questioned our lowering of the U.S. rating last year by pointing to the drop in U.S. government bond yields since the downgrade. This, the argument goes, indicates that the creditworthiness of the U.S. is higher than our rating reflects. That represents a misunderstanding of what a rating is: our opinion about the risk of an entity's failure to pay debt in full and on time. But ratings are not the only consideration that investors factor into their investment decisions
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amid considerable downside risks, we anticipate more challenging credit conditions ahead.
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Could ESM And A European Banking Union Break The Link Between Sovereign And Bank Creditworthiness?
A proposal by European leaders to use the EU's rescue fund, the European Stability Mechanism (ESM), to directly recapitalize failing banks could be more positive for the ratings on sovereigns than on banks. This is because direct equity injections by the ESM into eurozone banks would likely come with conditions, which could make government support for banks less likely. Ultimately, better supervision as well as an effective resolution framework could be a more successful way of reducing the effect of bank creditworthiness on sovereigns.
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Credit FAQ: Introducing The Updated Surveillance Criteria For U.S. RMBS Backed By Pre-2009 Mortgage Collateral
The events in the U.S. over past few years have caused many in the mortgage market to re-think their approach to assessing RMBS. We are updating our criteria to better reflect changing credit risk of the U.S. RMBS transactions we rate. These adjustments will help highlight the differences in credit quality among the outstanding issues and increase the long-term stability of our ratings following the implementation of the criteria.
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The Credit Overhang: A Two-Year European Recession Would Likely Hurt Ratings In Various U.S. Corporate Sectors
Given the importance of Europe as a market for American goods and services, a prolonged economic downturn in the region would likely have material repercussions for revenues of U.S. companies in some major manufacturing sectors. The combined GDP for the eurozone and the U.K. was $10.6 trillion last year, highlighting the importance of the region as an economic block in the world economy. This places the region's output close to that of the U.S. and its GDP of $11.3 trillion.
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Default, Transition, and Recovery: U.S. Recovery Study: Recent Post-Bankruptcy Recovery Levels Disappoint Senior Unsecured Bondholders
Following some recent bankruptcy restructurings, lenders are recovering amounts far below par on senior unsecured bonds. Recoveries averaged 33% in 2010 and 2012 (through May)--significantly lower than the longterm average of 43%. Several senior unsecured bond instruments associated with issuers that recently emerged from bankruptcy, such as General Maritime Corp. and The Great Atlantic & Pacific Tea Co., have generated recoveries of less than 5% of the principal amount.
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U.S. Public Finance Economic And Credit Conditions Forecast: Overall Improvement Will Likely Slow With Some Exceptions
U.S. economic growth slowed during the second quarter, according to various indicators. This loss of momentum is factored into our economic forecast. In addition, we have increased our probability estimate of recession within 12 months to 25% from 20%, where it had been since February 2012. In so doing, our economists notched down their forecast of several drivers of the state and local government credit environment. These developments have implications for both periods of our current sector forecast: calendar years 2012 and 2013.
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The U.S. Bond Insurance Industry Is On A Path To Reemergence, But Of A Different Profile
We believe there's still a need for municipal bond insurance, particularly for smaller, less-frequent issuers and small retail investors. The bond insurance sector has the potential to grow, but it will be of a different profile than it was a decade ago. We expect the overwhelming amount of business underwritten by the insurers to be U.S. public-finance par.
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U.S. Not-For-Profit Health Care System Ratios: Stability In 2011 Gives Providers A Firm Foundation To Face Industry Changes
The 2011 medians for U.S. not-for-profit health care systems were stable compared with a year earlier and have in many cases returned to 2007 pre-recession levels following the 2008 and 2009 lows. The broad stabilization in the fiscal 2011 ratios was evident across most metrics and at virtually all rating levels, although there were some changes at individual rating levels. The median trends highlight management's continued focus on improving the balance sheet and, to the extent possible, the income statement.
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U.S. Not-For-Profit Stand-Alone Hospital Ratios: Providers Confront A Difficult Road After A Stable Ride In 2011
The median ratios of U.S. not-for-profit stand-alone health care providers were generally steady in 2011 apart from some modest improvements and a few declines. The rating and outlook distributions remained comparable with the prior year. Balance-sheet metrics inched up and were generally at or near pre-recession highs due to good cash flow and lower-than-historical capital spending. Earnings and coverage ratios were stable, with most rating levels seeing only slight changes from a year earlier.
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Greece Outlook Revised To Negative On Likely Financing Shortfalls For 2012; 'CCC/C' Ratings Affirmed
The negative outlook reflects the potential for a downgrade if shortfalls in Greece's 2012 deficit and arrears targets established under the current EU/IMF program are not met by new funding or other relief from members of the Troika (the EU, European Central Bank, and IMF). We see the likelihood of shortfalls, due to election-related delays in the implementation of budgetary consolidation measures for the current year, as well as the worsening trajectory of the Greek economy.
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CDO Spotlight: CLO Issuance Is Surging, Even Though The Credit Crisis Has Changed Some Of The Rules
So far this year, the number of new CLO transactions has surged. As the number of new rated CLOs climbs, several trends have emerged that differentiate these deals from their pre-crisis counterparts. For example, postcrisis CLOs generally have higher levels of subordination providing credit support to the senior-most notes. In addition, newer vintage CLOs contain provisions that intend to provide clarity with respect to certain issues and behaviors that arose during the credit crisis of 2008 through 2010.
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