Treasury Today Country Profiles in association with Citi

Corporate credit ratings: bearing good news

Standard & Poors

Credit ratings agencies often get a bad press, and in some cases this may be justified. But they rarely receive any plaudits for work well done. Now one ratings agency is trying to raise awareness of a change in corporate ratings methodology that it thinks will make the ratings process clearer and more comparable.

Assigning corporate credit ratings may appear to be a pretty thankless job to some. When things go wrong, ratings agencies can get a lot of stick: the Big Three agencies came in for severe criticism for their ratings of collateralised debt obligations (CDO) – instruments which, according to one academic, were responsible for $542 billion in write-downs at financial institutions between 2007 and early 2009.

And just earlier this month Corte dei Conti, Italy’s supreme audit institution, claimed the major credit ratings agencies had failed to consider the country’s rich cultural history when downgrading its credit rating, and could be liable for massive damages of €234 billion. Standard & Poor’s (S&P) called the claim “frivolous and without merit”.

Yet it is hard to think of a high-profile case of a ratings agency being publicly praised. Sound, accurate ratings, or methodologies that make it easier for the market to interpret ratings rarely gain many column inches.

Now S&P is working hard to publicise what it considers a good news story in corporate credit ratings.

Transparency and comparability

The ratings agency is currently in the process of hosting events in major cities throughout the world to raise awareness around its revised corporate ratings criteria. The new criteria, which impact non-financial companies, include changes to S&P’s corporate methodology, ratios and adjustments, country risk, industry risk, group ratings methodology and ratings above the sovereign. S&P has also updated its key sectorial credit factors, which help translate how the criteria apply.

Peter Kernan, Managing Director, Criteria Officer, Corporate Ratings EMEA, told Treasury Today that increasing the transparency and comparability of ratings were key goals of the revised criteria. “This rewrite wasn’t about looking to improve ratings performance, which continues to be strong, in terms of default statistics, it was about being much more transparent in explaining how we arrive at our ratings. By bringing enhanced transparency, we will provide market participants with ratings which are more consistent and more comparable across all the regions and industries that we’re working in,” he says.

Kernan says that in addition to having a more deliberate and conscious forward-looking basis for ratings, the new criteria also provide a whole extra dimension of detail as to their derivation. “The previous criteria were missing a level of detail about how the individual risk categories are weighted and how they interact to produce the overall rating. The new criteria are explicit in identifying the risk factors and in defining exactly how we arrive at our ratings, so it will be much easier for treasurers and issuers to understand how their rating is derived and to debate and challenge us” he adds.

S&P issued a request for comment (RFC) to garner feedback on its (then) proposed criteria mid-way through last year and Kernan says the response was on the whole positive. “Most respondents were appreciative of the fact that we were looking to provide greater levels of specificity and transparency,” he says.

However, S&P also strove to adapt the elements of the proposals that were less well received before the formal publication of the new criteria in November. For example, while market participants were largely happy with the revised criteria on surplus cash, some – particularly European corporates – found S&P’s planned adjustment for working capital investment needs flawed. As a result, S&P removed this part of the proposal, and the final surplus cash criteria does not include any allowance for a WC adjustment (although WC analysis is covered in its liquidity criteria).

Before the official launch of the revised criteria, S&P said that 75% of ratings revisions impacted by the new rules would result in upgrades, and indeed, in the week following the implementation of the changes in November, 22 European corporate issuer ratings were placed on S&P’s ‘CreditWatch positive’ as a result of the revised criteria, while all other European corporate issuer ratings were unaffected. In the US, 57 issuers were placed on ‘CreditWatch positive’, while 15 were placed on ‘CreditWatch negative’.

The role of judgement

Some treasurers have cautiously welcomed the clarifications in the revised criteria, while others have shown concern at what they see as the over-formalisation of the new criteria, which they think downplays the role of judgement.

L’Association Française des Trésoriers d’Entreprise (AFTE) praised S&P’s “proactive approach to criteria evolution” in a written response, but also set out some of its reservations, including the warning that “rating must not become scoring” – implying that the new methodology could lead to too mechanical an approach to credit rating.

From the point of view of corporates, they just want a rating they can trust. “It’s a question of reliability: corporates may find it difficult to rely on ratings that are in a state of flux. The ratings agencies need to be clear on whether changes in ratings are down to new methodologies in their calculations, or underlying changes in the issuers. If they change their methodologies too often with inadequate communication, this could lead to a breakdown in trust,” says the treasurer of one German-listed corporate.

However, if S&P’s revised criteria ultimately do bring greater transparency and comparability to corporate ratings, surely that can only be good news for corporate treasurers.