Quantifying credit risk | World Finance

With more attention than ever on credit ratings, Blaise Ganguin, EMEA Head of Corporate & Infrastructure Ratings, Standard & Poor?s Ratings Services, asks whether they actually do the job they are designed for

The track record of our corporate ratings as indicators of default risk is very strong and has remained so during the financial crisis. But before examining this track record in detail, it is important to state what a credit rating actually is, and just as importantly, what it is not.

A credit rating is an opinion about relative credit risk; the creditworthiness of an issuer or credit quality of an individual debt issue. It is not a guarantee of credit quality or an exact measure of the probability that a particular issuer or particular debt issue will default. For example, a corporate bond rated ?AA? is viewed as having a higher credit quality than a corporate bond with an ?A? rating. The ?AA? rating is not a guarantee that it will not default, but rather that it is less likely to default than the ?A?-rated bond.

The performance of ratings can be measured objectively by how well they correlate over time with defaults, and by their stability. Our studies consistently demonstrate a clear correlation between ratings and defaults, and that ratings are progressively more stable as you ascend the ratings scale.

A nation?s going rate
In Standard & Poor?s long-term rating scale, issuers and debt issues that receive a rating of ?BBB?? or above are generally considered by regulators and market participants to be ?investment grade?, while those that receive a lower rating are generally considered to be ?speculative grade?. Between 1981 and 2011, the average five-year default rate for investment grade corporate issuers was 1.17 percent, compared with 16.82 percent for speculative grade companies. In Europe over the same period, the average five-year default rate for investment grade corporate issuers has been 0.5 percent, compared with 11.15 percent for speculative grade companies.

In line with all our previous default studies, the 2011 study showed that entities with higher ratings default less frequently than those with lower ratings, higher ratings are more stable than lower ratings and speculative-grade ratings generally experience more volatility. This is applied across all regions.The Gini ratio ? a key measure of the relative ability of ratings to differentiate risk ? was at its sixth-highest level since our default studies began in 1981. This demonstrates that the ability of corporate ratings to serve as an effective measure of relative risk remains intact.

Risk of default
Looking specifically at Europe, ratings also continued to serve as effective indicators of relative credit risk in 2011, with a clear negative correlation between ratings and defaults. Despite increased uncertainty among European sovereigns, only four rated corporate issuers in Europe defaulted in 2011, affecting debt worth $5bn. No investment-grade-rated entities defaulted in 2011. All four European defaulters in 2011 were nonfinancial companies, with all four defaulters initially rated ?BB+? or lower, and rated CCC or CC prior to default.

Expressed as a percentage of the rated universe, the speculative-grade corporate default rate in Europe ended 2011 at 1.6 percent and speculative-grade corporate default rates in 2011 were 1.71 percent globally. When including all rated entities, Europe recorded a default rate of 0.34 percent at year-end 2011, compared with 0.18 percent at the end of 2010. Higher-rated companies took longer, on average, to default than lower-rated companies did, while stability rates were higher for companies with investment-grade ratings than they were for companies rated speculative grade. Just over 80 percent of European issuers rated ?A? at the beginning of 2011 were still rated ?A? at the end of the year, whereas the comparable measure for issuers rated ?B? stood at 64 percent.

Reasons to be optimistic
Although the rating distribution in Europe remains solidly in investment-grade territory, the share of investment-grade entities continued to decline in 2011. Issuers rated ?BBB-? or higher accounted for 73.6 percent of all ratings at the end of 2011, compared with about 78.5 percent in 2010. In summary, in 2011 corporate ratings continued to perform in line with their strong historic track record. Higher rated companies had greater credit stability, lower default rates, and they took longer to default than lower rated companies.

It is important to remember that a high rating is not a guarantee that an issuer or debt issue will never default, or that the rating won?t change suddenly. Creditworthiness can and does change, sometimes as a result of unexpected and unpredictable events.

Source: http://www.worldfinance.com/strategy/investor-relations/quantifying-credit-risk?utm_source=rss&utm_medium=rss&utm_campaign=quantifying-credit-risk

nfl mock draft project m rubio colts colts big ten tournament 2012 dennis quaid