SP Global Ratings An Introduction to Ratings Nichol
S&P Global Ratings An Introduction to Ratings Nichol Merritt Director, Business Development Josh Buksbaum Director, Business Development Kiley Nixson Associate, Business Development Permission to reprint or distribute any content from this presentation requires the prior written approval of S&P Global Ratings. Copyright © 2019 by Standard & Poor’s Financial Services LLC. All rights reserved.
S&P Global Ratings: Global Reach In business for 150+ years Provides global reach and local knowledge with an office network spanning 35 countries Approximately 1, 500 ratings analysts issuing ratings on 130+ countries $48 trillion in debt rated by S&P Global Ratings More than 1 million credit ratings outstanding on government, corporate, financial sector and structured finance entities and securities Provides perspective on the creditworthiness of an entity or the debt it issues *Data as of 31 Dec 2018. Total number of Credit Analyst Supervisors: 128. Source: NRSRO form Source for $ in new debt rated: Source : S&P Global 2019 Investor fact book, S&P Global Ratings website (offices) 2
What Is A Credit Rating? It Is. . • A forward-looking opinion about the ability and willingness of an issuer, such as a corporation or government, to meet its financial obligations in full and on time (i. e. creditworthiness) • A potential global comparable across sectors • A view on the relative likelihood of default applied to entities (issuers) and securities (issues) • One of many inputs available to investors as part of their decision-making process It Is Not. . • A guarantee of credit quality or default probability • Investment advice or recommendation (buy, sell or hold) • A measure of liquidity or price • A way of defining “good” or “bad” companies • An audit of the company 3
Polling Question #1: Are you familiar with what a credit rating is used for? A) No, I am not B) Yes, I am aware of credit ratings and what they are used for C) Yes, I currently work for a company that has a credit rating 4
Why get a credit rating? To get the lowest cost of funding • While this is an issuer paying market; credit ratings are ultimately for investors • Credit ratings help investors understand relative creditworthiness • Credit ratings help investors understand how much capital to allocate to an investment, and hence, how to price it To help drive new business • Be able to differentiate between you and competitors on RFPs and JVs • Reduce the amount of capital that your business partners have to hold due to you, reducing their costs 5
Origins of Ratings: Created to rate Railway Bonds S&P Global Ratings: 1860 Henry Varnum Poor first published the "History of Railroads and Canals in the United States" in 1860, the forerunner of securities analysis and reporting to be developed over the next century Moodys: 1900 John Moody first published "Moody's Manual" in 1900. In 1909 Moody began publishing "Moody's Analyses of Railroad Investments“ Fitch: 1913 John Knowles founded the Fitch Publishing Company in 1913. In 1924, Fitch introduced the AAA through D rating system that has become the basis for ratings throughout the industry 6
Rating Agencies by the Numbers Total Number of Outstanding Credit Analysts 2019 NRSRO Report NRSRO • S&P #1 in Total Ratings Outstanding • S&P #1 in Financial Institutions Ratings • S&P #1 in Corporate Ratings • S&P #1 in Government Securities Ratings S&P Total Ratings Credit Analysts 1, 058, 211 1, 557 Moody's 690, 923 1, 714 Fitch 288, 251 1, 269 DBRS/Morningstar 54, 444 396 EJR 19, 094 17 KBRA 12, 316 156 A. M. Best 8, 253 147 JCR 3, 882 64 HR Ratings 1, 243 45 Source: Exhibit 8 on Form NRSRO, as in effect as of each NRSRO’s annual certification for the 2018 calendar year filed on or before March 31, 2019. Source: NRSRO annual certifications for the 2018 calendar year, Item 7 A on Form NRSR 7
Our Ratings Categories Investment Grade Speculative Grade AAA Extremely strong capacity to meet financial commitments. Highest rating. AA Very strong capacity to meet financial commitments. A Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances. BBB Adequate capacity to meet financial commitments, but more subject to adverse economic conditions. BBB- Considered lowest investment grade by market participants. BB+ Considered highest speculative grade by market participants. BB Less vulnerable in the near term, but faces major ongoing uncertainties and exposure to adverse business, financial or economic conditions B More vulnerable to adverse business, financial and economic conditions, but currently has the capacity to meet financial commitments. CCC Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments. CC Highly vulnerable; default has not yet occurred, but is expected to be a virtual certainty. C Currently highly vulnerable to non-payment, and ultimate recovery is expected to be lower than that of higher rated obligations. D Payment default on a financial commitment or breach of an imputed promise; also used when a bankruptcy petition has been filed or similar action taken. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. See “Ratings Definitions” on www. spglobal. com/ratings. 8
Polling Question #2: If your company were to be rated, is there a rating goal your company has in mind? A) Unsure, that has yet to come up in discussion B) Yes, at least Investment Grade C) No D) We are currently rated 9
Ratings: Raising Capital Through Rated Securities Issuers issue rated securities to raise capital Issuers Intermediaries Investors purchase rated securities 10
Global Corporates – Ratings Distributions https: //www. spglobal. com/ratings/en/research/articles/200625 -credit-trends-global-corporate-debt-market-state-of-play-in-202011546901 11
Default Risk: What Our Research Shows The lower the corporate rating the higher the likelihood of default The higher the corporate rating the lower the likelihood of default Of all the companies we rated as “investment grade” nearly 1%defaulted within 5 years Of all the companies we rated as “below investment grade” over 14% defaulted within 5 years (BBB- and above) from 1981 to 2019 (BB+ and below) https: //www. capitaliq. com/CIQDot. Net/Credit. Research/SPResearch. aspx? Document. Id=44748379&From=SNP_CRS Private & Confidential 12
Benefits of a Rating on Debt Issuance Increase distribution of debt offering: • CLO Investors (require rating to invest) • Insurance Companies • Traditional Mutual funds (Fidelity, Lord Abbett, PIMCO) a) Many institutional investors have investment criteria which requires they purchase only rated debt, typically 1 of 3, or 2 of 3 ratings from S&P, Moody’s or Fitch. They can buy unrated, but usually have a smaller bucket Why does this matter? Broad placement of debt offering, increases liquidity in secondary market. 13
NAIC (National Association of Insurance Commissioners) The NAIC is the U. S. standard-setting and regulatory support organization created and governed by the chief insurance regulators from 50 states 14
Why Does this Matter? Most traditional mutual funds have investment criteria which requires they purchase only rated debt, typically 1 of 3, or 2 of 3 ratings from S&P, Moody’s or Fitch. They can buy unrated debt, but usually have a smaller bucket Ø While issuers engage us for ratings, the real users are investors and ratings are one of the key inputs to pricing on the debt. 15
Size of US Corporate Bond Market* Total Size of US Corporate Bond Market Q 1 2019: $9. 597 Trillion (Investment Grade and High Yield) 2005 $4. 648 Trillion 2019 $9. 597 Trillion Growth Nearly Doubled! Mutual Fund Corporate Bond Assets, Growth in the past 14 years 2005 $1. 355 Trillion 2010 $2. 589 Trillion 2019 $4. 704 Trillion US CLO Issuance 2005 $52. 59 Billion 2019 $118. 32 Billion Asset Growth Tripled! *SIFMA Fact Book 2020 pgs. 21 & 33 Private & Confidential 16
Uses of Credit Ratings – Access Capital Markets: Drivers Growth of CLO Market Loan Market Composition: Rated vs Unrated Institutional Term Loans Source: LCD, an offering of S&P Global Market Intelligence 17
Access Capital Markets: Term-Loan B Market • Efficient pricing and distribution • Demand driven by CLO investors and Institutional investors • NAIC slotting may be derived from ratings, which helps attract Insurance investments • Diversify funding sources Loan Market Spreads: Rated vs Unrated Institutional Term Loans Spread Differential: 90 bps between Rated and Unrated Source: LCD, an offering of S&P Global Market Intelligence 18
S&P Global Ratings is engaged with the market: North America Frequent contact with the market at a global level helps to raise the profile of companies rated by S&P Global Ratings – about half of all meetings conducted are held with institutional investors. Globally, S&P Global Ratings’ analysts held 32, 971 meetings throughout 2019 [CATEGORY NAME] [VALUE] [CATEGORY NAME][VALUE] [CATEGO RY NAME] [VALUE] [CATEGORY NAME] [VALUE] [CATEG ORY NAME][ VALUE] [CATEGO RY NAME][V ALUE] [CATEGORY NAME] [VALUE] Across North America, S&P Global Ratings’ analysts held 17, 205 meetings throughout 2019 Structured Finance [VALUE] USPF [VALUE] Sovereigns & IPF - [VALUE] Insurance [VALUE] Infrastructu re [VALUE] Financial Institutions [VALUE] Corporate s [VALUE] Cross-Practice [VALUE] 18
Sectors with Specific Rating Needs 1. Bank: Deposit Gathering, Letter of Credit 2. Asset Management: Attract investors who require ratings: Pension funds, sovereign wealth funds, Asian Investors 3. Real Estate Asset Management: Counterparty/Tenant Creditworthiness 4. Insurance: Advantageous capital treatment on investments 5. Direct Lenders: Exposure to insurance sector through Separately Managed Accounts (SMA) 20
Corporate Criteria “simplified” Part 1: Corporate Analysis • What do you do and where? • How well do you do it relative to your peers? Part 2: Key Credit Factors • Scale - Relative Size and Strength • Scope - Depth and Breadth • Diversity • How are you financed? - Geographic Balance - Supplier Concentration 21
Traditional Capital Raise and Cost Savings on Issuance: Usage Case #1 • Company ABC needs to raise capital for M&A, general corporate purposes, growth. • Assume company has revolver/warehouse or similar facility and needs to raise additional capital / term debt Steps: 1. Identify/Engage an Investment Bank (JPM, Goldman, Jefferies); usually has some type of relationship in place 2. Determine amount of debt and structure i. Term Loan B ii. Bonds/Notes 3. Engage rating agency to issue rating on company and offering (usually 2 of 3 rating agencies) 22
Potential Cost Savings/Benefit of Including a Credit Rating on Bond Issuance: Usage Case #1 $250 mm, 7 -year, High-Yield Corporate Bond could potentially result in $4. 3 mm in interest savings over the life of a bond. 1 Credit Rating on Bond Issuance 2 Unrated USD 250, 000 Principal USD 250, 000 7. 25% Coupon 7. 0% Additional Interest Expense/Year (25 bps x $250 mm) $625, 000 7 year Term Total Extra Interest Cost $4, 375, 000 This is what all CFO’s care about 1 The $4. 3 million savings figure is hypothetical in nature, and results are not guaranteed. Factors that could impact results include, but are not limited to, potential excess market liquidity, relative sector attractiveness/cyclicality, levels of underlying security in the transactions included in the study. 23
Polling Question #3 Is ESG a topic of interest at your company? A) Yes; Investors are asking B) Yes; This is a focus of management C) Both A & B D) No 23
Environmental, Social, and Governance (ESG) Focused on innovation 24
Polling Question #4 What sustainability initiative(s) does your company have in place? A) We have a ESG Evaluation, or intend to acquire one in the near term B) We have a sustainability/corporate responsibility focused team C) Sustainability hasn’t been a major focus of our firm D) Both A & B E) None of the above 25
Credit Trends According to our Analysts: We expect the U. S. trailing-12 -month speculative-grade corporate default rate to rise to 12. 5% by June of next year from 5. 4% this year. To reach this baseline forecast, 229 spec-grade companies would need to default. Through the first half of 2020 there has been $323 billion in corporate fallen angel debt, with much of this concentrated in a handful of large issuers. The automotive, oil and gas, and transportation sectors saw the most fallen angels since March, which is consistent with our expectations for heightened credit stress for these sectors amid the COVID-19 pandemic. In contrast, the 'BBB' segment has also seen record bond issuance after the Federal Reserve and European Central Bank included corporate bonds in their massive liquidity support programs in March. Thus far the speculative-grade bond market appears to have comfortably absorbed debt that was recently downgraded from 'BBB', though most bonds from recent fallen angels have been trading at relatively high levels compared with the speculative-grade composite. Based on our prior forecast for fallen angel debt in 2020 of $640 billion, we still expect another $329 billion of 'BBB' downgrades from the U. S. and Europe, Middle East, and Africa regions in the second half of the year. 26
Credit Trends According to Bankers: Investment Grade • The general consensus was that IG issuance in the first half of the year was the strongest ever, but it will likely taper off into the Fall, as companies have addressed their capital needs for the year. The updated view is continued strong demand for good credit paper. High yield: • New issue market looks strong through end of October. • In mid-year, there was more demand for stronger rated credits i. e BB vs B issuance, this dynamic has changed heading into Q 4 as lower-rated credits (B and B-) are in strong demand by yield-hungry investors. Reasons: low rates, demand for yield, low issuance in Q 2 and Q 3 due to pandemic. • Bifurcation of the market has now balanced out - in mid-year stronger credits were in demand investors shunned lower rated “B” credits – Investors are now buying B and B- paper. Expanding on this shows that sectors that were less impacted by Covid are in strong demand (Tech, healthcare). Investors are still not interested in distressed sectors (Transports, retail, leisure) • Continued strong demand for BB credits. Note: Ballcorp (BB+) priced $1. 3 bln financing at 2. 875%, which is an all-time low • Companies in the same rating category are seeing a difference in access to capital, an approximate difference of 250 bps. Larger issuances are pricing much stronger, while smaller issuances are faring far worse. Investors want large, liquid names. 28
Bank Loan Pricing and Case Study: Pricing by rating level: Bond Pricing and Case Study: Pricing by rating level: 28
Credit Trends Continued: • Total loan volume down 23% y/y (vs. 25% the month prior) • HY bond issuance spikes in Aug up 76% y/y (vs. up 49% the month prior). Disregard weekly numbers • HG bond issuance continues pace up 84. 3% y/y. Disregard weekly numbers. 29
Questions Joshua Buksbaum Director - Business Development Corporate and Financial Institutions O: 212. 438. 2029 | C: 917. 742. 7946 joshua. buksbaum@spglobal. com Kiley Nixson Associate - Business Development Corporate and Financial Institutions O: 303. 721. 4815 | C: 720. 635. 8234 Kiley. Nixson@spglobal. com Nichol Merritt Director - Business Development Corporate and Financial Institutions C: 347. 325. 2437 Nichol. Merritt@spglobal. com To access any S&P Ratings or research, please visit https: //www. spglobal. com/ratings/en/ 31
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