Treasury Today Country Profiles in association with Citi

Agents of fortune: the value of a credit rating

Colourful dreamcatchers

A credit rating is generally a requirement of public bond issuance and for some companies is an essential means of accessing debt markets. We look at what it means to be rated.

A credit rating is the considered forward-looking opinion of a professional independent credit rating agency (CRA) concerning the relative ability of an entity to meet its financial commitments. The overarching aim is to provide necessary transparency, independence and consistency to the capital markets to help investors assess and price risk. The rating could be either international or national with ratings running in parallel. The latter concerns only issuers in their home market, meaning a higher rating could be achieved nationally than internationally (see the case study below) but giving access only to the domestic markets and currency.

The aim in all cases is to bring transparency and consistency to the assessment of creditworthiness, aiding the accurate pricing of credit risk. Once attained, the chief benefit of a rating is the increased comfort that independent analysis gives to investors, potentially opening up a wider pool of investors. To achieve a rating, a corporate will have undergone a high level of disclosure and evaluation and, so for investors, although prudence suggests other sources of information should be added to the mix (not least the more detailed ‘personal’ story of the corporate issuer), ratings are commonly seen as a benchmark for helping to make investment decisions.

When rating a corporate, CRA analysts will source and sift a wide range of public and private qualitative and quantitative data. Once issued, public credit ratings are thereafter continually monitored and assessed in terms of issuer performance, providing stakeholders with as accurate, timely and consistent a picture of relative creditworthiness as is possible. Of course, it is up to the market to decide if that rating is useful or not.

For companies that have slid down the scale, even if it has moved into ‘junk’ territory (junk is predominantly an investor term, CRAs prefer ‘high-yield’ or ‘non-investment grade’), CRAs will continue rating it all the while there is debt outstanding, although if the information required to maintain the rating is not available (such as if the company is in liquidation) the rating can be withdrawn by the CRA. “Generally, regardless of rating level, investors would want and need a rating on all outstanding debt,” says Anjali Sharma, Head of Business and Relationship Management for EMEA Corporates, at Fitch Ratings.

The reality of deriving a credit rating is complex for the CRA not least because it must put its view into a very broad commercial context. “By assigning a rating, we are not just providing an opinion and a rationale about a company but we are also comparing it to all the other companies that we rate,” explains Moody’s William Coley, SVP Credit Policy, EMEA Corporates. Using a common language to discuss credit quality thus means an individual rating from one CRA allows an investor to compare relative creditworthiness regardless of the class of debt it is applied to. Although not all CRAs will take the same view of that creditworthiness, well-known equivalency amongst their ratings make for easy comparison.

The Big Three and the competition

The first ratings agency was effectively created in 1900 by Wall Street errand-boy, John Moody. Poor’s Publishing Company (the precursor to S&P) climbed on the bandwagon in 1916, and both were joined by Fitch in 1913. Today, the so-called Big Three issue an estimated 95% of the world’s ratings. However, there are 94 other credit rating agencies and organisations spread across 44 countries globally.

“By assigning a rating, we are not just providing an opinion and a rationale about a company but we are also comparing it to all the other companies that we rate.”

William Coley, SVP Credit Policy, EMEA Corporates, Moody’s

The obvious power of the three main players has created a desire to break that stronghold. Scope, an agency with offices in London, Paris, Madrid and Frankfurt, vowed to become an “alternative to the status quo”, taking on the Big Three in its European homeland. It first offered corporate ratings in 2012 following its merger with PSR Rating, a Germany-based firm specialising in the analysis of mid-size automotive companies.

In November 2013, credit ratings organisations from five countries (CPR of Portugal, CARE Rating of India, GCR of South Africa, MARC of Malaysia, and SR Rating of Brazil) formed a joint venture to launch ARC Ratings, a global agency that also had its sights set on the Big Three. Today it has 18 offices and about 400 ratings staff. By way of comparison, Moody’s alone employs 10,400 people worldwide and maintains a presence in 36 countries.

Concern that the Big Three credit ratings were not meeting the needs of emerging economies saw the rise of Hong Kong-based Universal Credit Rating Group (UCRG). ‘The only international credit rating agency based in the Asia Pacific area’ was officially founded in 2013 as a partnership between China’s biggest ratings agency, Dagong Global Credit, the US-based investor-funded Egan-Jones Ratings, and Russia’s privately-owned RusRating. Its inception was hailed by former senior World Bank vice-president Ana de Palacio as an “invaluable asset” that can take on companies which now dominate the global industry.

More choice for corporates means more transparency of opinion for investors but also perhaps increased confusion for corporates. Ratings advisors can guide companies through the selection and subsequent processes. This role is often taken by the lead bank employed by the corporate to bring its bonds to market. “A rating advisor can be invaluable for a company considering a rating for the first time,” notes Sharma, adding that more than one CRA may be used at one time and that changing agency is possible.

From top to bottom

Issuers will normally be given a rating as a business (Fitch for example refers to this as the issuer default rating). In addition, all its debt issuances can be rated separately (for Fitch, this is the instrument rating). If, for some reason, the company does not agree with the rating decision it can appeal to the CRA if it provides materially new or additional information, but there is no specific right to do so.

Broadly, ratings range from investment grade (where, for example, S&P’s AAA is at the top, down to its BBB- at the bottom) to the non-investment or high-yield grade, which for S&P ranges from BB+ down to D (D being a state of default). For all but defaulted ratings, or (in Fitch’s case) very lowly rated issuers where default risk is already very high in the ‘C’ to ‘CCC’ rating categories, the CRAs also offer a ‘rating outlook’ to guide investors on the likely direction of the rating over a one- or two-year period. This dynamic but self-explanatory assessment ranges between ‘positive’, ‘stable’ or ‘negative’, with the option of placing the issuer on a shorter timeframe (three to six months) ‘rating watch’ where events dictate, again citing a negative or positive stance based on the expected outcome of a major event (such as an M&A).

“A rating advisor can be invaluable for a company considering a rating for the first time.”

Anjali Sharma, Head of Business and Relationship Management for EMEA Corporates, Fitch Ratings

A ratings watch can be applied when something material is expected to change the credit profile, explains Sharma (a debt-funded acquisition that might materially affect the leverage metrics, for example). A rated company will already have, she adds, “rating headroom” at its existing rating level whereby it has a degree of latitude before it would become necessary to consider changing the rating.

Although a low rating may be seen as undesirable or even “insulting”, the high-yield end of the spectrum it opens up for corporates still has an important role to play. “There really should not be a stigma attached to a lowly-rated company because ultimately a corporate can choose to operate at a capital structure that provides an optimal return for its shareholders,” explains Sharma. Indeed, it could decide to operate as a more highly leveraged company which may result in non-investment grade status. “Ultimately it is the company’s decision as to what capital structure it feels is appropriate for itself and for its shareholders,” she notes. And clearly there is an investor base covering all ends of the ratings spectrum.

Building an accurate picture

“When a company is thinking about getting a rating, the sooner they engage with the rating agency the better,” advises Sharma. The reason is simple: at the time a bond is being launched, the company will be going through many different concurrent processes including bond documentation, meeting with lawyers and bankers, and organising roadshows.

The first step forward with the agency in the (typically) two to six-week process, is to create a formal ratings presentation of key facts and figures. This also entails a detailed Q&A session with the CRA. Because CRAs do not give advice, the presentation may be prepared in-house by the company or with the guidance of its ratings advisor.

From here, methodological analysis will call upon a broad sweep of qualitative and quantitative data. It will include aspects such as financial profile, cash flow, earnings, capital structure, financial flexibility, corporate governance and group structure. To achieve a rounded view, typically a CRA would start with the previous three to five years’ of audited accounts giving it a base in terms of historical performance of the company. The base analysis will be supplemented by details on the business plan including its market position, anticipated transformative events (such as major M&A), product portfolio, geographical presence, operational scale and flexibility and so on.

Ultimately, a rating must be forward-looking, so history is never going to be the sole source, says Coley. Forecast information will therefore be required and it is likely that once all data has been aggregated, stress testing certain scenarios will help create that view.

It may be that a company wishes only to dip a tentative toe in the credit rating pool, in which case it may opt for a private, rather than public rating. This, Coley explains, allows the company to develop a relationship with the agency and industry analysts in a private setting. The advantage is that it enables the company to understand the way in which external parties view its credit status, how the agency rates it relative to its peers, and also to understand the key ratings drivers in terms of its ongoing ratings performance. It will then be the decision of the company – not the CRA – to choose when it wishes to make its rating public.

Managing the message

All ratings are subject to regular reviews by the CRA’s rating committee, typically annually, although awareness of any grounds to examine it will call the rating committee to action at any time. Unlike price-based market-implied ratings, which may change from day to day, the purpose here is not just to provide ratings accuracy but also deliver a degree of ratings stability for investors and issuers. “Part of the essential role of managing a rating relationship and having the right rating out there is that it should be at least somewhat resilient to everyday volatility,” explains Coley. Ensuring this requires the identification and setting out in advance of the key drivers that could influence a rating. Such events might relate to a planned M&A or divestment, or the publication of the annual report.

Of course, as ratings need to be forward-looking, all CRAs value a transparent relationship with their corporates. And, says Coley, wherever possible if a company is announcing a transformative event (such as an acquisition) “it is helpful for us to know what is coming, giving us an opportunity to form our view in advance of it happening”. The alternative is to run the risk of being placed on review, possibly for a downgrade, at least until the CRA has had time to formulate a full opinion and response.

Sometimes though events take on a life of their own. A company that has had an otherwise successful recent history may suffer a negative blip in a run of otherwise good fortune. CRAs must try to assess and calibrate such an event rather than having an automatic reaction. The recent events that led to the Moody’s A3-rated Volkswagen putting aside over €16bn to cover its diesel emissions crisis is a case in point. Because the lines of communication were kept open and management remedial plans were discussed, the firm’s rating was able to be maintained. “There is a lot of interaction and judgement applied,” states Coley. “It is certainly not a mechanical process, we don’t just look at historical figures or react on a hair-trigger basis to results as they come through.”

Case study

Taking the plunge: Mahindra & Mahindra

When in October 2015 India-based multinational Mahindra & Mahindra (M&M) was assigned a Baa3 issuer rating with stable outlook by Moody’s (matching India’s sovereign rating) the company – which was already AAA-rated by a number of domestic credit rating agencies (CRISIL, India Ratings, ICRA and CARE) – it joined a select group of Indian corporates with investment grade status.

M&M is a $16.9bn multi-sector business headquartered in Mumbai, with a presence in more than 100 countries. K Chandrasekar, the group’s EVP of Corporate Finance & Investor Relations, says the international rating not only enhances the “finance brand” of M&M but also adds credence to its Mahindra Rise programme which aims to place the company amongst the top 50 ‘most admired global brands’ by 2021. “The initiative to get this rating was a step in tune with this aspiration,” he comments.

The decision to go with Moody’s was based on M&M’s pre-rating evaluation of the agency’s philosophy and rating methodology, coverage and industry understanding. This starting point led to “meticulous preparations involving data room, details and presentations”. A “crack team of finance professionals” researched, assembled and presented their findings to Moody’s. “The team undertook to understand Moody’s ratings of various industries and companies and the underlying drivers for ratings, linking this to our businesses,” explains Chandrasekar. Preparations were both “challenged and enriched” by the nature and structure of M&M and the team sought help from M&M’s relationship banks “whose interactions assisted us in appreciation of the process and enhanced our level of preparedness by practising shadow-rating exercises”.

Prior to this exercise, M&M had been “mulling about the ratings for quite some time,” notes Chandrasekar. The team was aware of the resources it had to dedicate to create the right outcome but once engaged, although demanding, he says the process was also exciting. “It was in a sense, also a deeply reflective exercise and at the end of it, despite the toil and sweat, the leadership and the team felt enriched.”

With the rating secured, the importance of dialogue “at good and bad and in fact at all times” is acknowledged says Chandrasekar. “Sticking to agreed information sharing is a hygiene but ensuring a constant level of engagement is the real key. We have now started implementing this in our relationship with all our rating agencies.”

Although having an investment grade rating “gave the entire ecosystem of the group a boost”, Chandrasekar points out that the most “visible and immediate” impact is on treasury activities. “It improved our international access to capital and credit lines – and now even the most conservative of international banks have made a beeline to us,” he notes. “Today we are known not only as a sound treasury but also as an externally benchmarked treasury.”

Having been through the process, Chandrasekar is ready to impart his wisdom to other corporates seeking a rating. For any business aspiring to become a global company “it is an obvious thing to do”, but it is better to be done much in advance of raising capital, and then not just to fulfil a rating requirement. The exercise itself is “a long drawn-out one” in which business and finance functions “have to tango together”. As such, he feels it pays to have a team approach “and to take it in all earnestness as a self-discovery for the company”. However, he adds, the three most important elements for success are “preparation, preparation, preparation”.

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