I will very irregularly have any time for a full post over the next few weeks due to work pressures. I seem to be spending most of my time here trying to sort out one commenter on what I believe to be his misunderstandings of banking. Oh well.
Just for your reading pleasure, though, I read a very good post regarding the role and future of the Credit Ratings Agencies on the usually excellent “The Sheet” today. Have a read – it is worth it.
Conclusion:
The agencies proved that they are poor at rating complex structured finance products. Their approach to rating sub-prime mortgage backed securities was not sufficiently rigorous and their models for assessing other more complex products were inadequate.
By virtue of this, their opinions on these products should now be viewed as being of little value and the market should effectively withdraw the agencies’ ‘licence’ to rate such products. This will open the door for new specialist structured finance ratings agencies to enter the market.
This seems a better approach than more regulation and the unintended consequences that could result.
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5 comments
14 October, 2009 at 05:08
Andrew
Can anyone tell me what the PD’s are for corporate ratings. Its certianly not easy to find, so as an investor investing in say a BBB- company, how do I know what the risk really is compared to investing in a BBB company ?
Likewise what makes BBB- investment grade and BB+ speculative ?
14 October, 2009 at 10:39
Andrew
Andrew,
These mappings are normally fairly private – the agencies do not always want you to be able to back-test for them. There are also (to be fair) some differences between the way that Basel II tells you to do the PD calc and the way that the CRAs have done it for decades. Some mappings for the most important grades, though, are:
If you map those on an Excel graph you can interpolate the rest.
The difference between “investment” and “speculative” is really a silly one, though – as the PDs are a continuous line the cut-off between the two of them is really arbitrary. It is often (although not uniformly) taken to be at around the 1% PD level – roughly where the mapping above puts it.
If I were writing an investment policy, though, I would shy away from putting hard limits on these. As the piece I linked to above shows, the CRAs have a somewhat sub-optimal record on certain products.
27 October, 2009 at 05:19
Andrew
Thats great – thanks for the reply.
27 October, 2009 at 10:10
Andrew
Sry – one further thing – are these over a 1 year horizon or 5 years ?
27 October, 2009 at 12:20
Andrew
Basel II is (according to the Accord) over a 1 year time horizon, with IBNR losses included – i.e. those that are already on track to being in default are not counted as being in default until they are actually in technical default.
This, BTW, is the major difference between the Accord and the relevant accounting standards – the standards only count the IBNR defaults as losses, not any of the going forward losses.