Role of third rating agencies in the market for public debt : is Fitch different from Moody's and Standard

127 Pages·1997·4.2 MB·English

by  Jewell, Jeffrey Jay

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.