Role of third rating agencies in the market for public debt : is Fitch different from Moody's and Standard PDF
Preview Role of third rating agencies in the market for public debt : is Fitch different from Moody's and Standard
THEROLEOFTHIRDRATINGAGENCIESINTHEMARKETFORPUBLIC DEBT:ISFITCHDIFFERENTFROMMOODY'SANDSTANDARD&POOR'S? By JEFFREYJAYJEWELL ADISSERTATIONPRESENTEDTOTHEGRADUATESCHOOLOFTHE UNIVERSITYOFFLORIDAINPARTIALFULFILLMENTOFTHE REQUIREMENTSFORTHEDEGREEOFDOCTOROFPHILOSOPHY UNIVERSITYOFFLORIDA 1997 ACKNOWLEDGMENTS Thispaperwouldnothavebeenpossiblewithouttheadviceandguidanceof manypeople. AmongthosewhodeserveaspecialthanksareProfessorsMiles Livingston,ChristopherJames,andMarkFlannery. IalsothankBartDanielsen, RichardWarr,andHuiYangforthemanyhelpfulsuggestionstheyhavemadeoverthe courseofthisproject. Inaddition,Ithankmyothercommitteemembers,Professors JoelHouston,RoyCrum,andBillBombergerfortheirpatienceandcooperation. Finally,Ithankmywife,Dana,andourchildren,Ali,Maddie,andJ.C.fortheirlove andunderstandingthroughout thetermofthisenterprise. u TABLEOFCONTENTS Page ACKNOWLEDGMENTS ii ABSTRACT vi CHAPTERS INTRODUCTION 1 1 2 BACKGROUNDONBONDRATINGS 10 TheBondRatingAgencies 10 TheBondRatingProcess 13 RecentFitchHistory 15 3 REVIEWOFTHELITERATURE 18 LiteratureComparingRatingsofFitch,Moody'sandS&P 18 LiteratureonRatingChanges 22 LiteratureonSplitRatings 26 4 DESCRIPTIONOFTHEDATA 35 FullSample 36 MatchedSample 36 MarchSample 37 FitchMarchSample 38 5 SUMMARYSTATISTICS 40 6 COMPARINGRATINGLEVELS 45 ComparingMeanRatings 45 ComparingSplitRatings 48 7 COMPARINGRATINGCHANGES 61 FrequencyofRatingChanges 61 ComparingMagnitudeofRatingChanges 63 TestsofCausalityinRatingChanges:WhoChangesFirst? 70 MarketReactionAroundRatingChanges 74 iii 8 SPLITRATINGSANDTREASURYSPREADS 101 SplitRatingRegression 101 FitchSplitRatingRegression 106 9 CONCLUSION 115 REFERENCES 117 BIOGRAPHICALSKETCH 120 IV AbstractofDissertationPresentedtotheGraduateSchool oftheUniversityofFloridainPartialFulfillmentofthe RequirementsfortheDegreeofDoctorofPhilosophy THEROLEOFTHIRDRATINGAGENCIESINTHEMARKETFORPUBLIC DEBT:ISFITCHDIFFERENTFROMMOODY'SANDSTANDARDAND POOR'S? By JeffreyJayJewell August1997 Chairperson:ProfessorMilesLivingston MajorDepartment:Finance,Insurance,andRealEstate Recently,theacademicliteraturehasdebatedtherolethat'third'ratingagencies suchasFitchandDuff&Phelpsplayinthepublicdebtmarkets. Thevastmajorityof publicdebtissuesreceiveratingsfrombothMoody'sandStandardandPoor's. Therefore,itisnotclearwhyadditionalratingsarerequiredbysomefirms. Theone knownfactaboutFitchratingsisthatonaveragetheyarehigherthanratingsfrom Moody'sandStandardandPoor's. Thishasleadtospeculationthatthethirdagencies havemorelenientratingstandardsthanMoody'sandStandardandPoor's,andshould thusberegulated. Thepurposeofthisdissertationistoperformacomprehensivecomparisonof theratingsofFitch,Moody's,andStandardandPoor'sovertheperiod1991to1995in ordertodetermineifFitchratingsconveyanyincrementalinformationaboutdefault risktothemarket. Theratingsofthethreeagenciesarecomparedinthefollowing areas:meanratings,frequencyandmagnitudeofratingchanges,timingandmarket reactiontoratingchanges,andmarketpricingofratings. Severalinterestingresults werefound. First,Fitchisshowntohaveahighermeanratingthantheothertworating agencies. However,themagnitudeofdifferenceisfairlysmall. Infact,Fitchis showntoagreewithMoody'sand/orS&Pattheletterratinglevelapproximately90% ofthetime. Second,Fitchchangesitsratingsfarlessfrequentlythanthemajor agencies. Moody'sandS&Parebothfoundtochangetheirratingsalmosttwiceas frequentlyasFitch. Thiscouldbeacompellingreasonforfrequentdebtissuersto obtainaFitchrating. Ratingsstabilityshouldleadtoamorepredictablecostof capital. Finally,Fitchratingsarefoundtoaddsignificantexplanatorypowerto regressionmodelsoftheTreasuryspreadagainstbondcharacteristics. Thisindicates thatthemarketdoesindeedfindincrementalinformationintheFitchratings. Therefore,itislikelythat,ifregulationstoinsureuniformityinratingtechniquesare enacted,theendresultwoulddomoreharmthangood. Uniformityinrating techniqueswouldlikelydestroythemarginalinformationthatiscontainedintheFitch ratings. VI ' CHAPTER 1 INTRODUCTION Bondratingshavelongbeenconsideredanimportantpartofthecredit certificationprocessbygovernmentregulators,firms,andthegeneralpublicinthe issuanceofpubliccorporatedebt. Theacademicliteraturehasvigorouslydebatedthe importanceofbondratings. However,aconsensusappearstohavebeenreachedthat ratingsdoconveyimportantinformationtothemarketaboveandbeyondthatconveyed byfinancialinformationalone. Recentdevelopmentsinthecreditratingindustryhaveraisednewquestions abouttheroleofthebondrating,particularlywhenmultipleratingsareobtainedforthe samedebtissue. CantorandPacker(1995)pointoutthattherehasbeenarecent increaseinthenumberofagenciesratingpublicdebt. Therearecurrentlyfourfull serviceratingagenciesthatrateawidevarietyofdebtissues: Moody's,Standardand Poor's(S&P),Fitch,andDuff&Phelps. Inaddition,theyhavebeenjoinedinthe industryrecentlybyseveralspecializedratingagencies.2 AccordingtoCantorand 1SeeHand,Holthausen,andLeftwich(1992),ReiterandZeibart(1991), Ederington,Yawitz,andRoberts(1987),LiuandThakor(1984)amongothers. 2Forexample,ThompsonBankwatchandIBCA,bothstartedintheearly 1990s,ratefinancialinstitutiondebtexclusively. A.M.Bestratesinsurance companies'abilitytopayclaimsexclusively. 2 Packer,theSECcurrentlydesignatessixagenciesasnationallyrecognizedstatistical ratingorganizations(NRSROs),andseveralmoreagencieshaveapplicationspending withtheSEC. Itisclearthatfirmsseekingtoissuepublicdebthavemorealternatives thaneverbeforeinobtainingarating. Inaddition,itappearsthatmorefirmsare seekingthirdandevenfourthratingsfordebtissues. Whilethenumberofagenciesratingdebthasincreasedrecently,our understandingoftheroletheseagenciesplayhasnot. Infact,untilrecentlyonlythe ratingsprovidedbyMoody'sandStandardandPoor'shadbeenstudiedbyacademics. LittleisknownaboutratingsfromFitchorDuff&Phelpsexceptthatonaveragetheir ratingsappeartobehigherthanthoseissuedbyMoody'sandS&P.3 Dueto differencesinmarketshare,reputation,andoperatingproceduresbetweenMoody'sand S&PontheonehandandFitch,Duff&Phelps,andotherratingagenciesontheother hand,itisnotclearthatresultsfromresearchdoneonratingsfromMoody'sandS&P shouldgeneralizetoratingsfromtheotheragencies. Moody'sandS&PbothmaintainapolicyofratingmostSECregistered,U.S. corporatedebtsecurities,thusensuringthattheseissuestypicallyhaveatleasttwo ratings. Theseratingsareissuedregardlessofwhetherthefirmrequestsarating. However,firmswillingtopayaratingfee4gainthebenefitofparticipatinginthe CantorandPacker(1995, 1996)documentthisfact. Theyalsoshowthat pDaurftfo&ftPhhiseldpisffaenrdenFcietc(hb.utnotall)canbeexplainedbydifferencesinthefirmsratedby 4AccordingtoCantorandPacker,typicalfeesonnewlong-termcorporatedebt rangefrom2to3basispointsoftheprincipalforeachyeartheratingismaintained. 3 ratingprocess,whichallowsthemtoputtheirbestcasebeforetheagencies (Cantor andPacker, 1995). AccordingtoEderingtonandYawitz(1987),lessthan2%of domesticissuersreceivingaratingfromS&Pfailtopaytheratingfee. OtherratingagenciesfollowverydifferentpoliciesfromMoody'sandS&Pin ratingdebt. Forexample,FitchandDuff&Phelpsonlyratedebtissuesuponrequest fromtheissuingfirm. BothoftheseagencieschargefeescomparabletoMoody'sand S&Pfortheirservices. Thisraisesthequestionofwhyfirmsarewillingtopayfor theseadditionalratingsontheirdebtissues,giventhattheyhaveprobablyalready receivedratingsfromMoody'sandS&P. Thetrendtowardsobtainingmorethantworatingshasthepotentialtoaddan additionallayerofcomplexitytoassessingafirm's'true'creditrisk. Evenwhengiven accesstothesameinformationandhearingthefirm's'bestcase',Moody'sandS&Pdo notalwaysreachthesameconclusionaboutthecreditworthinessofadebtissue. Severalstudiesintheliteraturedocumentthatapproximately13%-17%ofU.S. corporatedebtissuesreceivedifferentletterratingsfromMoody'sandS&P(asplit rating).5 Thenumberofissuesreceivingsplitratingsatthenotchlevelapproaches 50%. Asthenumberofratingagenciesincreases,itislogicaltoassumethatthe numberofdebtissuesreceivingsplitratingswillincreaseaswell. Thus,more informationisavailablewhentherearemorethantwoagencies,buttheinformationis notnecessarilyeasytointerpret. 5SeeBillingsley,Lamy,Marr,andThompson(1985)andJewellandLivingston (1997)amongothers. 4 OnepossibleexplanationofferedbyCantorandPackerfortheincreaseinthe useofthirdratersisregulatoryinnature. Manyfinancialinstitutionshavelimits, eitherselfimposedorimposedbygovernmentregulators,ontheamountsofdebtthey canholdofcertainratings. Traditionallythecutoffratingofinterestwasthatbetween investmentandnoninvestmentgradesecurities(BaaandBaontheMoody'sscale). However,recentregulationshaveestablishedotherimportantcutoffsattheAaand evenAratings.6 Asmostoftheseregulationsonlyrequirethatthehighestorsecond highestratingbeabovethecutoffpoint,thefirm'schancesofmeetingthestandard increaseifathirdorfourthratingisobtained. Therefore,firmscouldhaveastrong incentivetoobtainmultipleratingsinordertomakeitpossibletoselltheirdebtto theseregulatedinstitutions.7 Addingtothedesirabilityofobtainingathirdorfourthratingisthatoncea ratinghasbeenrequestedfromFitchorDuff&Phelps,itisonlymadepublicifthe firmissatisfiedwithit. Thus,requestingaratingfromFitchorDuff&Phelpsis similartobuyinganoptiononarating. Thishastheeffectofinsuringthatlowerthan 6Forexample,CongresshasestablishedtheAAratingasthecutoffin determiningtheeligibilityofmortgage-relatedsecuritiesandforeignbondsascollateral formarginlending. InadditiontheNationalAssociationofInsuranceCommissioners hasadoptedcapitalrulesthatgivethemostfavorablecapitalchargetobondsratedAor above.(CantorandPacker, 1995) 7Livingston,Pratt,andMann(1995)documentthatinvestmentgradebonds havefarlowerunderwriterfeesthanhighyieldbonds. Onelikelyexplanationforthis isthatinvestmentgradebondsareeasier(cheaper)tosellduetothelargenumberof regulatedinstitutionswhichmayparticipateinthismarket. Theauthorsdonot examinetheeffectofsplitratingsonunderwriterspreads.
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