Credit ratings
Credit ratings

The following Restructuring & Insolvency practice note provides comprehensive and up to date legal information covering:

  • Credit ratings
  • Role
  • Identity
  • Ratings
  • Conflicts of interest
  • Over-reliance on ratings
  • Regulation of CRAs

Role

The role of credit rating agents (CRAs) is to provide an objective and analytical opinion on the risk of payment defaults by looking at various factors that help investors decide whether to invest in particular securities. Investors in capital markets are very sensitive to risk and some investors are prevented by their internal constitutional documents from investing in low grade securities. Generally the higher the investment risk, the greater the return (interest/coupon) the investor will seek.

Both (i) the company issuing the security instruments and (ii) the security instruments themselves can be rated, meaning that all of the following can be rated:

  1. the issuer

  2. senior debt/syndicated loans

  3. medium term notes (MTNs)

  4. commercial paper (CP)

  5. fixed income securities

  6. sovereign debt

  7. residential mortgage backed securities (RMBS)

  8. commercial mortgage backed securities (CMBS)

CRAs typically look at qualitative, quantitative and legal issues to decide on a credit rating, including:

  1. current financial statements plus profitability

  2. past performance

  3. projected performance (including cashflow projections and cash flow adequacy)

  4. strength of existing management, governance, risk tolerance, financial policy

  5. market position plus peer group comparison

  6. operating environment

  7. legal opinions

  8. guarantees/collateral

  9. country risk

  10. industry characteristics

  11. capital structure

The CRAs then apply stress tests to the structures to assess the impact of various negative events or harsh trading conditions. From 1 January 2016, under SI 2015/1945 certain banks must share information on their small and medium-sized

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