The role of the credit rating agencies for debt IR
From their Wall Street bastions, US rating agencies maintain a vigil over the financial landscape, alert to the smallest change. The likes of S&P, Moody's and Duff & Phelps Credit Rating Co strive to provide investors with high quality, objective, analytical information.
For those individuals concerned with debt investor relations - and therefore interested in influencing rating agencies - understanding their inner workings is critical. A good presentation can mean basis point savings in the debt raising process or a better positioning in terms of counterparty risk in financial transactions.
Even for IROs who spend hours refining a presentation for rating agencies, the results are unpredictable. Just ask Salomon Brothers and the Mayor of New York City. This summer Salomon angrily protested a ratings downgrade by S&P, and New York Mayor Rudolph Giuliani threw a small fit when the city's bond rating was downgraded.
These days, however, the rating agencies are more concerned about intervention from Washington than tirades from dissatisfied ratees. In recent years, ratings have been entrenched as regulatory tools, governing the activities of corporations, banks and investors. The result is that agencies themselves could be made subject to tougher regulation. This fall, the SEC will rule on several issues, including whether it should continue to insist firms be 'nationally recognised statistical rating organisations' (NRSROs) before they can publish ratings that can be used in regulation.
One of the stumbling blocks will be the hazy definition of the term NRSRO and the qualification process. This has been the cause of consternation for foreign firms trying to get the NRSRO imprimatur. Take IBCA, a British firm recognised in the US for its bank debt ratings, but not for its ratings of corporate debt. IBCA has been battling for full recognition since 1988.
US rating agencies vehemently oppose SEC intervention. Though they are interested in protecting their turf from interlopers, they fear regulation could extend to rating practices, placing their independence in jeopardy. 'Any attempt to impose a regulatory regime on NRSROs would adversely affect the functions performed by agencies in the US,' Leo O'Neill, S&P president, told the SEC. 'Ultimately, S&P's analytical judgement must remain independent of third parties, including the government.'
Moody's agrees with O'Neill's assessment. 'The credibility of ratings rests in the market place, not regulation,' says George Fasel, director of communications at Moody's. 'Moody's does not buy or sell securities. Nor does it have an opinion on the level of credit risk appropriate for any investor. If government wants to use ratings, fine. But they shouldn't govern them.'
When the dust settles in Washington, no matter what the outcome, a central fact will remain: their measurement of credit worthiness may sway investors, but rating agencies do not offer a recommendation on, or take a position in, any security. And whether a company chooses to purchase a rating, or is targeted by an investor-driven ratings process, the tag of a rating sticks with an issuer or a bank no matter what.
Moody's senior analyst Dennis Saputo underlines the impact of a rating on cost of capital. 'The balance of debt to equity is an economic analysis companies must make,' he says. 'Equity financing is more expensive, and CFOs worry about shareholder dilution. On the other hand, increasing debt load means the credit rating goes down and the cost of debt financing increases.'
William Chambers, S&P managing director of corporate finance, notes that the changing investment climate has put ratings in a new light. 'A rating is very much a proactive IR tool,' he says. 'Companies have to address a new class of money managers, pension funds and retail investors, many of them overseas. They may not understand a company, or be able to place it in the context of its peer group. A rating helps you break the loop and attract a wider group of investors. It shows that an analyst has gone through your operations and finances, even non-public information, and made a judgement on them. That says a lot to the market.'
Basically, S&P rates an issue only when there is adequate information to form an opinion, and only after extensive analysis. 'Ratings are by nature forward looking,' Chambers says. 'Historical financial statements are a good framework for discussion, but it is important to understand where the company is going. We develop a qualitative understanding of the sector and the competitive environment, and look at the economy of the country in which it operates.'
S&P advises issuers to begin the ratings dialogue early. And any enterprise in a state of transition, particularly in emerging markets, should allow time for a lengthy, in-depth rating analysis. Chambers also emphasises that S&P analysts want to work with the accounts used to run the business, not statements created for a rating agency. In emerging markets, S&P usually gets companies to prepare their financial statements according to international accounting standards to facilitate cross-border comparisons.
Since the 1970s, issuers have paid Moody's for ratings so the process starts with a request. 'As our corporate ratings guide makes clear, we do not review companies in exhaustive detail,' says Fasel. 'Rather, we concentrate on essential elements relevant to the issuer's risk profile. Typically, this is information already available to the company and regularly presented to senior management.'
Moody's analysis team comprises upwards of four members, including the lead industry analyst, other relevant industry specialists, and a rating director. The analytical meeting usually takes place at the issuer's headquarters, taking up to two days, with the whole process taking four to six weeks. The focus is on the company's background, strategy, operating position, financial and accounting policies, as well as other areas including derivatives activity, regulatory developments, future investments, and potential acquisitions.
'Management is critical to credit quality,' says Fasel. 'We benefit from meetings with senior executives by getting an understanding of their philosophy and plans for the future. We never tell a company what they should do for a better rating. Their job is to make their decisions, and our job is to evaluate the consequences for investors.'
When a preliminary rating has been selected, issuers are given a chance to offer information that might change the outcome. At the end of this process, the ratings are distributed simultaneously to the financial media worldwide, usually before each issue is released so that investors can use ratings in buying decisions. Beyond that, Moody's analysts spend most of their time monitoring outstanding ratings, continuously updating the results of their research.
For IROs seeking a less clinical approach, Duff & Phelps is worth considering. It began life in the 1930s as a research organisation, and branched into money management, consulting and credit rating. The rating division gained independence in 1980, and was spun off last year in an IPO on the NYSE. In recent years, DCR has broadened its perspective, establishing an office in London and considering a Singapore operation. DCR also has joint ventures throughout Latin America, India and Pakistan.
Duff & Phelps Credit Rating Co (DCR) is smaller than S&P or Moody's, and is proud of the fact. 'We are free from a lot of procedures and routines,' says Paul McCarthy, DCR president and CEO. 'We have higher quality meetings, and go deeper into strategy. The result is an opinion that is more than just a rating.' McCarthy places value on the personal approach, sitting down with issuers to discuss strategies or general business issues. 'One thing that often gets lost in ratings is personalities,' he says. 'But it is personalities that drive business.'
DCR gets its opinion to the Street in a myriad of ways. Besides press releases and its monthly rating guide for the financial community, the firm publishes the daily New Financing Reports on transactions, the weekly Credit Decisions, and the quarterly Credit Analysis Updates on various sectors. DCR also operates a hotline that releases ratings and takes requests for written research; and distributes its ratings through electronic services like Bloomberg and Telerate. In addition, full-text research reports are available on First Call's new Research Direct service. McCarthy doesn't rule out a Web page on the Internet in the future, either, saying: 'Give them what they want, how they want it.'
With its roots in institutional research, DCR enjoys a strong institutional investor following. 'The larger rating agencies don't explain their rating actions to the extent we do,' says McCarthy. 'Ours is an open rating process, and our most senior analysts spend a lot of time talking personally to institutional investors on the phone or at our conferences. Those investors are smart people, and we get feedback which can very often be communicated back to issuers - it's two-way communication.'