Grade Expectations

In response to the financial crisis, Standard & Poor’s is increasing the transparency around what we do and how we do it. The measures we are undertaking are aimed at supporting confidence in our ratings and helping investors make more informed decisions. With this in mind, we believe it is worthwhile reminding investors about the precise role and purpose of credit ratings and the firms, such as S&P, which issue them, as well as sharing the results of a recent survey into the current perception of credit rating providers.

To start off, it is important to make clear that credit ratings are future-oriented opinions about creditworthiness. Ratings express our opinion about the ability and willingness of an issuer, such as a corporation or government, to meet its financial obligations in full and on time. Yet ratings can also speak to the credit quality of an individual debt issue – such as those from a corporate or municipality – as well as the relative likelihood that the issue will default.

S&P’s ratings opinions are based on analysis by experienced professionals, who evaluate and interpret information from issuers and other sources to form a considered opinion about credit quality.

Separate methodologies are applied by each ratings firm in evaluating creditworthiness, using a specific rating scale to denote its ratings opinions. Typically, ratings are expressed as letter grades that range, in the case of S&P’s ratings for example, from ‘AAA’ to ‘D’ to communicate the firm’s opinion of relative level of credit risk. S&P uses primary analysts in forming our opinions of credit risk in the context of corporate and government ratings, sometimes in combination with mathematical models.

For instance, when rating a corporation or municipality, an analyst is assigned, often in conjunction with a team of specialists, to take the lead in evaluating the entity’s creditworthiness. Typically, analysts obtain information from published reports, as well as from interviews and discussions with the issuer’s management. They use that information to assess the entity’s financial condition, operating performance, policies and risk management strategies.

Alternatively, some ratings firms use a model-driven approach. In this respect the focus is almost exclusively on quantitative data, which is incorporated into a mathematical model. For example, a ratings firm using this approach to assess the creditworthiness of a bank or other financial institution might input that entity’s asset quality into a model, with funding and profitability based primarily on data from the institution’s public financial statements and regulatory filings.

Available current and historical information is evaluated in order to assess the potential impact of foreseeable future events. For example, in rating a corporation as an issuer of debt, S&P may factor in anticipated ups and downs in the business cycle that could affect the corporation’s creditworthiness. While the forward looking opinions of rating firms can, alongside other considerations, be of use to investors and market participants who are making long- or short-term investment and business decisions, credit ratings are not a guarantee that an investment will pay out or that it will not default.

It is important to emphasise, at this point that, while investors may use credit ratings in their decision making process, S&P’s ratings are not indications of investment merit. This means that the ratings are not buy, sell, or hold recommendations, or a measure of asset value. Nor are they intended to signal the suitability of an investment for a particular investor. They speak to one aspect of an investment decision – credit quality – and, in some cases, may also address what investors can expect to recover in the event of default.

Investors generally consider a number of factors when considering an investment in addition to credit quality. These include the current make-up of their portfolios, their investment strategy and time horizon, their tolerance for risk, and an estimation of the security’s relative value in comparison to other securities they might choose. A comparison might be the deliberations of a car buyer, who may consider that while reputation for dependability is an important consideration it is by no means the sole criterion on which to base a purchase decision.

Relative opinions

Of course, the assignment of credit ratings is not an exact science since there are future events and developments that cannot be foreseen. This means that S&P’s ratings opinions are not intended as guarantees of credit quality or as exact measures of the probability that a particular issuer or particular debt issue will default.

Instead, ratings express relative opinions about the creditworthiness of an issuer or credit quality of an individual debt issue, from strongest to weakest, within a universe of credit risk. For example, a corporate bond that is rated ‘AA’ is viewed by S&P as having a higher credit quality than a corporate bond with an ‘A’ rating. But the ‘AA’ rating isn’t a guarantee that the bond will not default, only that S&P believes it to be less likely to default than the ‘A’ bond.

Corporations and governments have found that credit ratings play a useful role in facilitating access to the capital markets. Instead of taking a loan from a bank, these entities sometimes borrow money directly from investors by issuing bonds or notes. Investors purchase these debt securities, such as municipal bonds, expecting to receive interest plus the return of their principal, either when the bond matures or as periodic payments.

In this way, credit ratings can play a part in the process of issuing and purchasing bonds and other debt issues as they are intended to provide a transparent, independent and widely available opinion of relative credit risk across a wide range of markets and asset classes. Investors and other market participants may use the ratings, for instance, as part of their investment decision making process as they seek to match the relative credit risk of an issuer or individual debt issue with their own risk tolerance or credit risk guidelines in making investment and business decisions.

Issuer survey

With our role explained, the context of a recent survey can be explored. Commissioned as a survey of European issuers’ assessment of ratings firms’ performance (and specifically S&P) by Standard & Poor’s Ratings Services, it took place against the backdrop of recent market dislocation that has put the ratings industry under intense scrutiny.

The survey was undertaken by an independent third-party research company on an anonymous basis in April 2009 and drew responses from 410 issuers (including corporates, governments and financial institutions, as well as issuers within the insurance, infrastructure and public finance sectors) located in 47 countries across Europe, the Middle East and Africa.

Perhaps the most significant finding in this latest survey is that issuers in the region continue to regard S&P’s product and service quality highly as compared to our previous survey, conducted in November 2007.

A total of 59% (60% in 2007) of respondents scored S&P’s ‘overall product and service quality’ as ‘excellent’ or ‘very good’, with a further 28% (29% in 2007) scoring it as ‘good’. Positive views about S&P’s analysts – including their overall knowledge and good communication – are the main reasons cited by European issuers as the basis for rating service/product quality at S&P so highly.

In addition, more than eight-in-10 respondents still value the S&P brand highly and associate it with trust. The word most commonly associated with S&P is ‘professional’, with ‘quality’ also receiving significant mention. In addition, 82% of issuers agreed with the statement, "I hold the S&P brand in high esteem" and 81% with the statement "the S&P brand is associated with trust".

Meanwhile, the survey also found that 60% of issuers believe S&P’s reputation (along with the other major firms) has declined in the past year. Unsurprisingly, the decline in the firms’ reputation is mainly attributed to the impact of the global financial crisis.

The issue of rating-firm reputation is still seen as vital with more than 80% issuers stating that reputation is ‘very important’ when evaluating a rating provider. Only 24% apply the same significance to cost. In fact, the three factors mentioned most often as being important when evaluating a rating provider are overall knowledge of the industry, transparency and quality of analysis.

While the survey found S&P’s reputation among the issuers has held up strongly, S&P is focusing its efforts on rebuilding trust among investors, whose views on ratings providers are critical. We have taken a variety of steps to improve our communication with fund managers, providing more information about our ratings and seeking their input on a range of analytical initiatives. In fact, some professional investors and other market participants are telling us they are keener than ever to hear our opinions on individual issuers, sectors and the macroeconomic environment, and – with credit risk now high on investors’ agendas – demand for our data, analytics and opinions continues to grow.

Certainly, S&P strives to maintain the highest quality standards and is committed to playing its role in the revival of healthy and sustainable global credit markets. We measure our success by the benefits the market as a whole derives from our ratings – and we are committed to maintaining an open dialogue with market participants as we continue to strengthen the quality of what we offer.