Corporate Financial Policy Rating Agencies

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Presentation transcript:

Corporate Financial Policy Rating Agencies Professor André Farber Solvay Business School 2001-2002 13/08/2019 Cofipo 2001-2002

References Bodie, Kane and Marcus, Investments, 4th ed. McGraw-Hill 1999 Moody’s, The Evolving Meaning of Moody’s Bond Rating – August 1999 Standard & Poors, European Default Rates Inch Closer to the Global Average, April 2002 13/08/2019 Cofipo 2001-2002

Rating Agencies Investment-grades Speculative-grades Moody’s (www.moodys.com) Standard and Poors (www.standardandpoors.com) Fitch/IBCA (www.fitchibca.com) Letter grades to reflect safety of bond issue Very High Quality High Quality Speculative Very Poor S&P AAA AA A BBB BB B CCC D Moody’s Aaa Aa Baa Ba Caa C Investment-grades Speculative-grades 13/08/2019 Cofipo 2001-2002

Determinants of Bonds Safety Key financial ratio used: Coverage ratio: EBIT/(Interest + lease & sinking fund payments) Leverage ratio Liquidity ratios Profitability ratios Cash flow-to-debt ratio Rating Classes and Median Financial Ratios, 1991-1993 Rating Category Coverage Ratio Cash Flow to Debt Return on Capital % LT Debt to Capital % AAA 6.34 0.49 24.2 11.7 AA 4.48 0.32 18.4 19.1 A 2.93 0.17 13.5 29.4 BBB 1.82 0.04 9.7 39.6 BB 1.33 0.01 9.1 51.1 B 0.78 (0.02) 6.3 61.8 Source: Bodies, Kane, Marcus Table 14.4 13/08/2019 Cofipo 2001-2002

Standard&Poor’s European Rating Distribution 1985 1990 1995 2000 2002 AAA 20 37 52 49 42 AA 14 59 117 171 185 A 6 159 315 350 BBB 141 244 Investment-grade 40 110 370 676 821 3 2 7 71 103 B 1 8 75 81 CCC 12 23 Speculative-grade 16 158 207 Total 43 113 386 834 1028 13/08/2019 Cofipo 2001-2002

Default Rate Calculation Incorrect method: Number defaults/Total number of bonds Ignores growth/reduction of bond market over time Ignores aging effect: takes time to get into trouble Correct method: cohort style analysis Pick up a cohort Follow it through time 13/08/2019 Cofipo 2001-2002

Moody’s:Average cumulative default rates 1920-1999 % 3 4 5 10 15 20 Aaa 0.00 0.02 0.09 0.20 1.09 1.89 2.38 Aa 0.08 0.25 0.41 0.61 0.97 3.10 5.61 6.75 A 0.27 0.60 1.37 3.61 6.13 7.47 Baa 0.30 0.94 1.73 2.62 3.51 7.92 11.46 13.95 Inv. Grade 0.16 0.49 0.93 1.43 1.97 4.85 7.59 9.24 Ba 3.45 5.57 7.80 10.04 19.05 25.95 30.82 B 4.48 9.16 13.73 17.56 20.89 31.90 39.17 43.70 Spec. Grade 3.35 6.76 9.98 12.89 15.57 25.31 32.61 37.74 All Corp. 1.33 2.76 4.14 5.44 6.65 11.49 15.35 17.79 13/08/2019 Cofipo 2001-2002

S&P: Average One-Year Transition Rates - Europe Rating at Jan. 1 AAA AA A BBB BB B CCC D NR 91.20 6.21 0.26 0.00 2.33 0.25 88.57 7.99 0.37 2.83 2.21 88.47 4.47 0.29 0.05 4.51 5.13 85.88 0.77 0.13 7.57 0.30 3.34 78.42 5.78 1.82 0.91 9.42 0.74 3.68 69.12 6.25 7.35 12.50 15.22 63.04 6.52 13/08/2019 Cofipo 2001-2002

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