This presentation in two parts was given at a Royal Holloway University London (RHUL) event on 22 March 2012. Part 1 covers CRAs and Part 2 covered career tips for students interested in the financial markets.
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Global Financial Markets & The Recent Credit Crisis: Impressions from a Personal Journey and Lessons for the Future
1. Global Financial Markets &
the Recent Credit Crisis:
Impressions from a Personal Journey and
Lessons for the Future
Markus Krebsz
22 Mar 2012
Evening Lecture & Student Event
2. 1) âLessons from the Financial Crisisâ
Lesson 1: Use of Credit Rating agencies (CRAs)
Lesson 2: What are CRAs?
Lesson 3: Inter-agency comparability?
Lesson 4: âSuper Seniorsâ (Intra-agency comparability)?
Lesson 5: Definition of âRatingâ
Lesson 6: Captured risks
Lesson 7: Constructive criticism
Lesson 8: Failures
Lesson 9: Risk of Over-Reliance & Mitigants
Lesson 10: Using CRAsâ analysis sensibly
__________________________________________
Appendix: Origin & History, Global CRAs, Rating scope,
Rating actions & Process, Benefits, Limitations 2
9. WHAT are Credit Rating Agencies?
⢠Rating agencies are intermediaries in capital markets
⢠They collate and evaluate information on the issuer, and
disseminate opinions to investors (and other interested
parties)
⢠Other intermediaries are banks and insurance companies
⢠Issuers expect reduced cost of funds
⢠Issuers expect access to broader investor pool
⢠Increased role of rating agencies:
- Financial disintermediation; bank/ borrower to
issuer/ buyer
- Regulation
9
12. RATINGS âMAPPINGâ TABLE
Fitch Ratings Moodyâs Standard & Poors Mapped
Long-term rating Short-term rating Long-term rating Short-term rating Long-term rating Short-term rating internal
r a t i n g
Investment Grade
AAA Aaa AAA iAAA
AA+ F1+ Aa1 AA+ iAA+
A-1+
AA Aa2 P1 AA iAA
AA- Aa3 AA- iAA-
F1+ or F1
A+ A1 A+ A-1 iA+
A F1 A2 P-1 or P-2 A A-1 or A-2 iA
A- F1 or F2 A3 A- iA-
P-2 A-2
BBB+ F2 Baa1 BBB+ iBBB+
BBB F2 or F3 Baa2 P-2 or P-3 BBB A-2 or A-3 iBBB
BBB- F3 Baa3 P-3 BBB- A-3 iBBB-
BB+ Ba1 BB+ iBB+
BB B Ba2 BB iBB
Speculative Grade
B
BB- Ba3 BB- iBB-
Ranges within
B+ B1 B+ iB+
B-1, B-2 and B-3
B B2 B iB
B- B3 Not Prime B- iB-
CCC+ Caa1 CCC+ iCCC+
C
CCC Caa2 CCC iCCC
CCC- Caa3 CCC- C iCCC-
CC Ca CC iCC
C C C iC
DDD, DD, D D
Moodyâs: D D D iD
Source: Bloomberg, Fitch, Moodyâs and S&P 12
15. RATING PRINCIPLES
Fitch Ratings, Standard & Poorâs:
Probability of default (PD) = First dollar of loss
ď¨ What is the ultimate default risk?
Moodyâs:
Expected loss (EL) = [(PD) X (LGD)]
ď¨ What is the amount of net loss suffered?
15
21. Q) How would you define âratingâ?
A) Benchmark measure B) Benchmark measure
for LGD for PD
C) Opinion
D) Not necessarily based on facts or
knowledge
21
22. RATING DEFINITION
⢠An opinion⌠* [Financial journalists]
⢠âŚon the relative abilityâŚ
⢠âŚof an entity to meet financial commitments.
*âŚview not necessarily based on fact or knowledge
Ratings are benchmark measures ofâŚ
⢠Probability of default (PD)
⢠Expectations of Loss given default (LGD)
22
24. Q) Which RISKS are captured by credit ratings?
A) Credit & Market risk B) Credit, Market & Operational risk
C) Credit, Market, Operational, Liquidity & Basis risk
D) None of the above
24
25. RATINGSâŚ
âŚcan capture: âŚdo NOT capture:
Credit risk ďž Market risk ďž
ďž Liquidity risk ďž
ďž Operational risk ďž
only ! ďž Basis risk (IR risk) ďž
âŚbut, even so, are âhard-wiredââŚ
⢠by Basel II
⢠into banksâ credit rating models
⢠Investment guidelines and Asset management mandates 25
30. FAILURES
AIG, Bear Stearns, Bradford & Bingley, Enron, Icelandic
banks, Lehman Bros., Monolines, Northern Rock, Parmalat,
Sovereigns (Eurozone), Sub-prime bonds etc.
In their own words...
Fitch: â⌠did not foresee the magnitude of the declineâŚor
the dramatic shift in borrower behaviorâŚâ
Moodyâs: ââŚWe did not . . . anticipate the magnitude and
speed of the deterioration in mortgage quality or the
suddenness of the transition to restrictive lending...â
S&P: ââŚIt is now clear that a number of assumptions used
in preparing ratings on mortgage-backed securities issued
between 2005 and mid-2007 did not workâŚâ
Source: US Government Oversight and Reform Committee, Oct 2008
30
32. OPERATIONAL RISKS
⢠Changing Rating methodologies and assumptions
⢠Time lag of rating actions
⢠Rating model risks
⢠âFat fingersâ, i.e. technical glitches
⢠Striking the right balance between non- and over-regulation
32
33. RISK MITIGANTS
⢠Understanding the meaning & limitations of ratings
⢠Understanding instrumentsâ risks
⢠Independent analysis
⢠Internal ratings
⢠Disputing rating decisions with the agencies
⢠Awareness that agencies CAN and DO get their ratings
wrong (Operational risk scenario)
33
35. SENSIBLE USE of CRAsâ Analysis
⢠Fully understand the instrument you are investing in â
particularly when using other peoplesâ monies
⢠Understand ratingsâ limitations and
know how to mitigate rating-related risks (previous slide)
⢠âIgnoreâ ratings designators (i.e. AAA etc.) and
focus on CRAsâ analytical narrative instead
⢠Look out for what is NOT there in the narrative but should
e.g. Why are obvious issues missing in the analysis?
Why has this bond not been rated by all three CRAs?
⢠Apply common sense and trust your gut feeling 35
36. Q) Would you now give CRAs more or less credit?
More ?
Less ?
36
37. APPENDIX:
Origin & History
Global Rating Agencies
The Rating Process
Benefits
Limitations
37
38. ORIGIN & HISTORY 1922 â Standard Statistics company
1841 â 1st mercantile rating agency
ďŽ Founded by Louis Tappan 1924 â Fitch Publishing company
ďŽ Rating merchantsâ ability to pay
ďŽ Taken over by Robert Dun 1933 â Merger: Dun & Bradstreet
ďŽ Becomes owner of Moodyâs in 1962
1849 â 2nd rating agency established
ďŽ By John Bradstreet 1941 â Merger: Standard & Poorâs
1859 â 1st rating guide published 1966 â Takeover: S&P by McGraw Hill
ďŽ By Robert Dunâs agency
1975 â Fundamental change
1909 â Moodyâs founded ďŽ Business model
ďŽ By John Moody ďŽ âSubscriber-paysâ to âIssuer-paysâ
ďŽ âManual of Railroad Securitiesâ
2007 to 2011 â Global credit crisis
1916 â Poorâs Publishing Company ďŽ Part blame for market collapse
ďŽ Publishes its first ratings guide ďŽ New rating agency regulation
38
39. WHO PROVIDES RATINGS?
⢠More than 2,400 institutions worldwide
⢠Ratings and analysis track debt covering more than:
⢠100 sovereign nations
⢠11,000 company issuers
⢠25,000 public finance issuers
⢠70,000 structured finance obligations
⢠Employs more than 2,400 people worldwide, ~1,000 analysts.
⢠Rates 170,000 corporate, government and structured finance
securities
www.moodys.com
39
40. ⢠6,300 employees
⢠Located in 21 countries and markets
⢠Has played a leading role for more than 90 years
⢠Ratings on US$ 34 trillion of debt issued in 100+ countries
⢠Issuers and debt obligations of corporations, states and
municipalities, financial institutions, insurance companies and
sovereign governments
⢠Ratings, indices, equity research, risk solutions
ďź S&P U.S. Indices
ďź S&P/Citigroup Global Equity Indices
ďź S&P Emerging Market Indices
ďź S&P Alternative Indices
www.ratingsdirect.com or www.globalcreditportal.com
40
41. ⢠Dual-headquartered in NY & London
⢠90 countries 1,500 employees
ďź 3,100 financial institutions
ďź 1,600 banks
ďź 1,400 insurance companies.
ďź 1,200 corporates, 89 sovereigns, 45,000 municipal
transactions.
ďź 8,600 structured finance transactions under surveillance,
including 4000 RMBS pools, 440 CMBS, 1600 ABS, and
600 CDOs.
ďź 1200 European & 200 Asian structured finance
transactions
www.fitchratings.com
41
44. THE RATING PROCESS: A detailed view (Part 1)
Source: Moodyâ s, S&P, Fitch Ratings
44
45. THE RATING PROCESS: A detailed view (Part 2)
Source: Moodyâ s, S&P, Fitch Ratings
45
46. BENEFITS
To Investors To the company (issuer)
⢠Safety to investments ⢠Easier to raise funding
⢠Recognition of Risk & ⢠Reduced cost of borrowing
Returns ⢠Reduced cost of public
⢠Freedom of investment issuance (bonds)
decisions ⢠Ratings help increase image
⢠Wider choice of & reputation
investments ⢠Facilitation of growth
⢠Dependable credibility of ⢠Access to wider investor
issuer base
⢠Easy understanding of ⢠Recognition of relatively
investment proposals unknown companies
⢠Continuous monitoring
(Surveillance) 46
47. LIMITATIONS
⢠Non-disclosure of significant information
⢠Static study of present and past historic data at one
particular point in time
⢠Rating is no certificate of soundness and users of
ratings should form an independent view of the meaning
of the particular rating
⢠Rating may be biased due to certain views of the lead
analysts
⢠Rating under unfavourable conditions which may not
always be representative of the true image of the
company
⢠Differences in rating grades: split ratings between
different rating agencies which may confuse investors
47
48. TIMELY ACTIONS and DEFERRAL
Timeliness of Rating changes Bond maturity profile
⢠Process stages to reach ⢠Legal final vs. expected
rating decisions maturity
⢠Detection of bond- vs. ⢠Life-time ratings (40+ years)
asset class-specific ⢠Timely payment of interest &
and/or systemic issues ultimate payment of principal
31 July 07 20 Aug 07 31 Aug 07 9 Oct 07 16 Oct 07 25 Oct 07
Cut-off date CRA analyst Proposal: RWN CRA Analyst Proposal: DG Indiv. or Asset-class?
Bulk rating
actions &
Report format & frequency, Analystâs experience, Models, Quorum ...
Criteria
15 Aug 07 27 Aug 07 25 Sept 07 12 Oct 07 23 Oct 07 You get
Distribution
st
1 Analysis result st
1 Committee nd
2 Analysis result nd
2 Committee the idea... Changes
48
50. 2) âTips & Tricks for working in the
Financial Marketsâ
Topic 1: Personal traits
Topic 2: Professional attitudes & values
Topic 3: Opportunities
__________________________________________
Appendix: Presenter biography, Book information
50
57. Desk / Network banking: Perception vs. RealityâŚâ
ââŚInvestment
ââŚKnow what happens to it when it leaves your deskâŚâ
ââŚSum of All Job Specs does not add up to 100%...â 57
58. ââŚThings other donât want to doâŚcan be very rewardingâŚâ
ââŚfind your âNicheâ, Specialism â or Island if you mustâŚâ
58
59. ââŚWalk awayâŚ
âŚfor 5mins every hourâŚ
âŚfor 30mins over lunchâŚ
âŚat a reasonable time at nightâŚ
âŚor completely if you had enoughâŚâ
59
60. ââŚIf you want to walk on waterâŚ
âŚyou got to get out of the boat!...â
60
61. ââŚMundane tasks need also doing
â make the most out of themâŚâ
ââŚEnjoy the RideâŚâ
61
62. ââŚBe a DiplomatâŚâ â⌠âBSâ DetectorâŚâ
ââŚPut yourself into
someone elseâs
shoesâŚâ
ââŚUnderstand your firmâs cultureâŚâ
62
66. âOpportunity is missed by most people,
because it is dressed in overalls
and looks like work.â
(Thomas A. Edison 1847 â 1931)
66
67. CLOSE
Thank you very much
for your attention, contribution and listening today!
________________________________________
________________________________________
CONTACT:
+ 44 (0) 79 85 065 045
www.markuskrebsz.info | www.creditratingsguide.com 67
68. Markus Krebsz
Subject matter expert : Rating agencies & Securitisation
⢠Freelance Consultant with nineteen years experience in banking & financial institutions - thereof ten years covering rating agencies
⢠Credit rating advisor for the World Bank as part of various large-scale projects involving GSEs of several African & Asian nations
⢠Industry expert in credit rating agency as well as Structured finance-related issues and frequent speaker on international conferences
⢠Author and passionate reviewer/editor of several risk workbooks
⢠Frequent contributor to various industry working groups consulting regulators, exchanges and central banks
Publications
⢠âSecuritisation & Structured Finance post Credit Crunch: A Best Practice Deal Lifecycle Guideâ, John Wiley & Sons Inc., Apr. 2011
⢠âProduct Taxonomy: A Key Tool for Understanding Risk/Return within the Banking Frameworkâ Qfinance chapter, exp. Jan 2012
⢠âInvestor Requirements for 2011 and beyond: Due diligence and Risk analysis in a post-crisis worldâ, Euromoney Yearbook chapter
⢠Workbooks of the Chartered Institute for Securities & Investments (CISI): âDerivativesâ (Senior Reviewer), âIT in Investment
Operationsâ, (Senior reviewer), âOperational Riskâ , (Senior reviewer) & âRisk in Financial Servicesâ, (Technical Reviewer)
⢠âFrontiers of Risk management â Chapter 14: Credit rating agencies and the IRB approachâ, Euromoney Book, 2007
⢠Numerous special, research and criteria reports on Fitch Ratingâs website as Performance & Rating analyst, Aug 2004 to Oct 2006
⢠SAP Risk Analyzer Manual (in-house publication, in German), Jan 2002
Professional qualifications & affiliations Assignments (Past & current)
⢠Individually Chartered Member of the Chartered ⢠The World Bank
Securities and Investment Institute (CISI) ⢠Deutsche Bank & UBS
⢠Bachelor of Banking Services and Operations, CCI ⢠Lloyds Banking Group
⢠âTrain the Trainersâ Certificate ⢠Bank of Scotland Treasury
⢠âBanking in Britainâ Certificate ⢠The Royal Bank of Scotland Group
⢠German Banking Certificate (âBankkaufmannâ) ⢠HypoVereinsbank / Unicredit
⢠Volunteer at and Member of the Professional Risk ⢠Dresdner Bank
Managerâs International Association (PRMIA) ⢠Primary insight (Subsidiary of Bear Stearns)
⢠Member of the Global Association of Risk ⢠De Matteo Monness (Subsidiary of Goldman Sachs)
Professionals (GARP)
⢠Fitch Ratings
www.markuskrebsz.info / www.markuskrebsz.co.uk ⢠Vista Research (Subsidiary of Standard & Poorâs)
68
69. More on Credit ratings and Analytical tools can be found here:
A special offer for a 30% discount (of the
RRP) for orders is currently available
for a limited time only,
if the order is placed directly at the
publisher's website www.wiley.com
and the promotion code 'VA817' is
entered.
Thank you for your interest.
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