 |
 |
|
News & Events |
|
|
|
|
|
|
 |
|
Media Coverage |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Media Relations |
|
|
|
We are always interested in speaking to members of the media on news and events affecting the world of corporate credit risk. We look forward to hearing from you.
Contact Media Relations Representative |
|
|
|
|
|
|
|
|
Rating agencies get the measure of the markets
Source: Financial Times
Date: May 28, 2004
Authors: Ellen Kelleher and Jenny Wiggins
Over the past century, as the capital markets have swollen to include myriad kinds of debtsecurities, investors have had few sources of guidance on how creditworthy thosesecurities are. The job of assessing them has fallen to analysts at a tiny group of companies, principally Standard & Poor's, Moody's Investors Service and Fitch Ratings.
The credit rating industry is changing, however. Investors are turning in greater numbers to new technologies and services that monitor market movements to judge credit risk, posing a challenge to the rating agencies' traditional qualitative methods of analysis.
The new-style quantitative analysis relies on "measurable" factors to assess a company's financial condition, including movements in bond prices, equity prices and interest rates. Investors can use this information to calculate the impact of price changes on a company's creditworthiness and estimate the likelihood it might default on its debt.
Fundamental analysis, in contrast, relies on balance sheets and income statements, and has usually ignored changes in market sentiment.
Market-based systems gained popularity in 2001 and 2002 when record numbers of bond defaults led investors to look for new ways to measure credit risk. "We have been using [quantitative services] for a few years," says Margo Cook, head of institutional fixed income at the Bank of New York, adding that while the bank would not rely solely on market-based analysis, it is one of the elements it uses to evaluate credit risk.
The rating agencies have reacted to this competitive threat by developing and acquiring their own market-based information systems, as well as incorporating market indicators - such as changes in credit default swap spreads - into their regular credit assessments.
"The development of financial technology has been very beneficial to our business," says Raymond McDaniel, president and chief operating officer at Moody's. "But we have to pay attention to what is happening so we remain relevant."
In early 2001 S&P established its Risk Solutions unit offering consulting services and financial models to help institutions manage their credit risk. The following year Moody's bought KMV, one of the best-known quantitative providers of credit and default risk analysis. Fitch has an affiliate, Fitch Risk, which offers consulting and modelling services, and expects eventually to provide tools estimating default probabilities, according to Gloria Aviotti, Fitch Risk's group managing director.
The emergence of market-based methods to monitor credit risk coincides with efforts by bond market participants to make bond prices more readily available. "Something that historically has been quite opaque is becoming more transparent," says Mr McDaniel. US corporate bond prices are now publicly available on a website run by the National Association of Securities Dealers.
Bonds trade "over the counter" - over the telephone and via computer - rather than on exchanges like stocks, and their prices historically have been difficult to monitor. As market transparency increases, however, changes in bond prices can be more accurately tracked.
The rating agencies say that as more companies use the public debt markets to raise money, it has become more important for them to watch changes in the prices of the debt securities they rate. A sharp fall in price can affect the ability of a company to access the markets and hence its ability to raise new debt or refinance old debt.
Market-based systems also help analysts keep tabs on a large number of companies. "Traditional forms of credit analysis cannot be easily scaled to do frequent analysis on a large number of exposures," says Moody's KMV.
"Moreover, the traditional forms tend to be judgment-based and dependent on the skill of the analyst exercising the judgment."
Meanwhile, changes in international bank regulations, known as Basel II, are expected to add to demand for systems that measure risk exposure. "The Basel proposals have really triggered a renewed focus, particularly by the banks, on their credit risk processes and systems," says Roy Taub, executive managing director, Standard & Poor's Risk Solutions.
No one expects rating agencies to disappear, partly because the use of credit ratings has been incorporated into federal securities laws. Changes in ratings still have a big influence on the markets because some investors operate under rules that force them to sell those securities whose ratings fall below a certain level.
Still, quantitative services are likely to make up an increasing proportion of the agencies' income in future. "It's among the more rapidly growing parts of the business," says Mr Taub at S&P, which declined to provide revenues for its Risk Solutions unit.
Moody's KMV accounts for about 10 per cent of overall revenues at Moody's and is expected to grow faster than the traditional ratings business, Moody's Investors Service, according to Mr McDaniel. Moody's KMV reported $81.5m (£44.9m) in revenues in 2002, compared with $941.8m of revenues for Moody's Investors Service over the same period.
Observers of the rating agencies say their move towards market-based analysis is a positive one provided they do not take it too far.
"As long as the analysts use the quantitative models in the appropriate way, it should be viewed as a helpful addition to fundamental credit analysis," says Kevin Rigby, global head of ratings advisory at Deutsche Bank.
Some observers worry that the rating agencies may come to rely too closely on market movements when making credit decisions, lowering ratings when they see a company's bonds deteriorate in value.
On the other hand the rating agencies, which were castigated after the collapse of Enron for not lowering the energy company's credit ratings quickly enough, have more recently been accused by some downgraded companies of being too quick to act.
The agencies say they are well aware of the impact their ratings can have, and insist that market-based indicators and credit services are only one tool among many used to evaluate a company's creditworthiness.
"We view market-based indicators as helpful information but the real drivers of our ratings are the underlying credit fundamentals," says Robert Grossman, chief credit officer at Fitch.
THE MARKET FOR RISK SYSTEMS SHOWS GROWING MOMENTUM
Persuading management to spend money on systems that spit out data showing whether companies might default on their debt used to be difficult work, writes Ellen Kelleher.
Six years ago, Jeffrey Bohn, head of research at Moody's KMV, did not shake hands on many deals when he travelled around the world on sales trips. He was more like an academic, spending most of his time educating information technology researchers in credit risk analysis software, not signing papers in corner offices. But today the pace of his job has quickened. "Five or six years ago, we were only selling to the largest financial institutions," Mr Bohn says. "Quantitative systems are not just an intellectual curiosity any more.
People are now saying they have to have these systems in place if they want to be competitive." Big banks began to adopt the systems a few years ago. Now smaller lenders, hedge funds, asset managers and companies with big portfolios such as Pfizer and Microsoft are starting to follow suit. "These systems supply more objective information, so at least people know when they are making bets," says Christopher Finger, head of products at RiskMetrics Group, a provider of risk management software. After the collapse of Enron, WorldCom and Parmalat, most financial organisations are hunting for better ways to monitor companies' creditworthiness. Global banks are interested for two main reasons. First, they will soon have to make their risk profiles more transparent to meet new requirements brought on by Basel II. Second, new market-driven systems allow them to get a better idea of what they should charge risky companies when they lend. "You couldn't aggregate risk across a large company like Citigroup without using this kind of technology," Mr Bohn argues. So far, the rating agencies Moody's and Standard & Poor's have made the deepest in-roads into the market. But after buying KMV, the biggest and most established provider of quantitative risk analysis, Moody's has the upper hand. It controls about three-quarters of the market. Smaller firms, including RiskMetrics - JPMorgan's former risk management group - are eager to expand. Last month Morgan Stanley acquired Barra, a California-based risk management system provider. But banks' own research groups are probably the biggest threat to Moody's monopoly. Many may go it alone and build their own models. Mr Bohn compares Moody's fight to gain share to the wars Macintosh and Microsoft waged in the 1980s. "Macintosh came up with the new way. Windows stole the paradigm and made all the money," he says. "We just don't want to become the Macintosh of credit risk analytics."
Back to Media Coverage Archive |
|
|
|
