The myth of equal ratings among credit rating agencies
di Lapo Guadagnuolo
Global Head of the Centre of Excellence for Methodologies S&P Global Ratings
Lapo Guadagnuolo is the Global Head of the Centre of Excellence in the Methodology group of S&P Global Ratings. Based in New York, Lapo oversees the development, application and maintenance of all general and cross-sector ratings methodologies, including the maintenance and consideration of changes to ratings definitions.
Previously based in London, Lapo held various senior roles like the Global Head of Analytics & Research, the Chief Credit Officer for the EMEA region, and the co-head of the EMEA Structured Finance department with more than 130 analysts and staff located in various offices.
Before joining S&P Global Ratings in 2001, he worked for Banca Popolare di Lodi in Italy.
Credit ratings have become a key component of the financial industry since decades. The request for independent evaluations of debtors creditworthiness has been on an exponential rise since the beginning of the 80’s, when bonds begun to acquire massive relevance in the international capital markets for the first time.
However, several misconceptions about the fundamental nature and scope of credit ratings persist even in these days. A common mistake is to consider the ratings from different rating agencies to mean the same thing. To better understand the point, let us use the three foremost international credit rating agencies in terms of worldwide market coverage: S&P, Moody’s e Fitch. Let us assume that of all of them have given a rating to the same company X, as it is laid out in the following table:
If we pose the following question to financial experts: “which rating agency has the lowest credit view of company X?”, 99.9% of them would give “Fitch” as the answer, as Fitch is the one which indicates the lowest rating on its scale. However, such reasoning is fundamentally flawed, as it ignores how differently rating agencies formulate and deliver their assessments from each other.
First, rating agencies do not necessarily express opinions with the same parameters in mind. Some of them focalize on, thus giving greater importance, to debtors’ capacity of sustaining progressively higher levels of creditstress without going into default; others are more specifically focused on the probability of a default; others again look more into the expected value of losses (so, they do not just consider defaults, but a company’s capacity for recovering too). Not only that: the very definitions of published rating categories vary among rating agencies.
Let us now look at how ratings are produced. These different measures and definitions are then codified in very specific criteria based on qualitative and quantitative factors, which the rating agencies themselves define at their own discretion and independently from each other. Finally, the rating to company X is given by a committee wholly independent from other rating agencies. All this, for simplicity sake, is finally expressed with symbols from one to three letters- as it is in the table. Therefore, thinking that a BBB from S&P means the same thing as a BBB from Fitch or a Baa of Moody’s is erroneous and does not give enough weight to the different parameters involved. That’s why it is always critical that investors actually read the published rating reports where they can understand all the thinking behind a rating, rather than stopping at the symbol.
To be fair, we must strike a blow for the 99.9% of financial experts, as it is true that the scales used by the three abovementioned rating agencies employ the same number of categories, that is seven (triple A, double A, single A, triple B, double B, single B and triple C) and the same concept of notches, namely no notch for the highest class, triple A, and two notches (+ and-) for every other class. And it is also true that cases where the same company X gets vastly different ratings on the specific credit scales of different rating agencies (e.g. a double A for an agency and an A for another) are few and far between. This could lead to the belief that a BBB by S&P means the same thing as a BBB by Fitch or a Baa by Moody’s, butsuch belief, however, is not reality.
19 October 2018
 The D rating (meaning “Default”) is not really a rating like the others. Ratings are symbols indicating how the agency subjectively assesses a debtor’s future creditworthiness. The D rating, instead, is a “statement of fact”, i.e. an objective recognition of a debtor’s default.
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