"The onus of research falls squarely on the shoulders of the investor." This is the opinion of Rabbani Wahhab, fixed interest fund manager at Aberdeen Asset Managers (Aberdeen). But the Basle Committee, due to meet next week to review the global banking system, may enforce a central role for the credit rating agencies to assess the banks' credit risk. Basle regulates the amount of debt banks can raise, currently based on the banks' capital ratio. But will investors want to be guided by the rating agencies? Some are no longer happy to rely blindly on Moody's and Standard & Poor's credit risk assessments. As one dealer points out: "The rating agencies don't always get it right." As a result, investors are choosing to do it for themselves. Moreover, the credibility of the rating agencies was shaken earlier this month when Unilever's long-term issuer rating and its debt issuance programme rating were downgraded from AAA to A by Standard & Poor's after Unilever bought Bestfoods. Moody's also downgraded Unilever's rating from AAA to A1 on July 11. An overnight drop of five grades has made many dealers question how accurate the ratings really are. Although ratings are still a key factor when an investor chooses an issuer, investors are beginning to use them more as a guideline, rather than an absolute indicator. And thorough research into an issuer's credit risk is becoming as important as the ratings. Wahhab, at Aberdeen, says: "When assessing the credit risk of an issuer we look at the rating as judged by Standard & Poor's or Fitch, but we also have our own research library. With less well-known issuers we need a face-to-face meeting with the finance management, and based on that we'd come out with a rating. We would also need to investigate accounts and financial ratios." This approach is deemed sensible even by the agencies themselves. Richard Miller, managing director, European Investor Services at Moody's, says: "We want investors to refer to our rating, read our research, and to talk to our analysts as a key part of conducting their own analysis. In our view it is equally bad to rely blindly upon the rating given by an agency, as it is to disregard them completely. Investors make best use of rating products and services when they actively seek to understand rationales in forming their own views about credit risk." And a rating also makes life easier for the dealer. Natalie Bowbrick, Euro-MTN dealer at ABN Amro, says: "Ideally investors prefer to have a good rating but it doesn't necessarily have to be a high rating. Most investors appear not to be so keen on unrated paper, however an implied rating supplied by the dealer's credit research department can help. It is easier to sell unrated notes in the issuer's domestic market because the name is probably better recognized." An MTN programme rating from Moody's costs $38,000 a year, according to the agency, and a charge of 3.25 basis points is then made for each note issued off the programme. To obtain an issuer rating on the other hand costs $30,000 a year. All but a few issuers feel that it is worth getting a rating. Anthony Everill, head of MTN trading at Merrill Lynch says: "Without a rating they are cutting out a large percentage of potential investors whose investment criteria require a rating. Of the 600 or so programmes that we are a dealer on, only a handful have no rating." Yet several issuers have chosen to enter the market this year without a rating. Banca delle Marche told MTNWeek on September 15, shortly before it was due to sign, that the rating "can't guarantee success." The issuer was confident that it could access investors in the capital markets even without a rating. And Interbanca joined the market in April 1999. It too is unrated but does not feel at a disadvantage. It has issued $936.15 million-worth of debt off the programme so far. Francesca del Nero, head of marketing at Interbanca says: "We would probably have more opportunities if we were rated, but most of our investors know us well. I would say a rating is a minor advantage, but we have had no difficulty in selling our paper." Del Nero also admits that many investors have conducted their own credit risk research into Interbanca. Investors who are willing to assess an unrated issuer have to do it thoroughly, which takes up a lot of resources. Wahhab, at Aberdeen, says: "We do buy from unrated issuers, but we have to get down to the nitty-gritty of the financial balance sheet and interview the management to ascertain protection." But some investors, especially in Japan, are limited to only buying paper that is rated by two of the main rating agencies. And many dealers strongly advise issuers to get a rating before they sign. Everill, at Merrill Lynch, adds: "Investors rely heavily on ratings. They may well do their own credit work, but they will also use the research provided by the rating agencies." And Wahhab, at Aberdeen, agrees that ratings do have an important role to play. But investors are becoming more aware that they have a responsibility to confirm any credit risk and the only way to do this is to do their own research. He says: "The rating is not becoming less important, but investors are getting more choosy. We're not the only ones who conduct our own research and that's not a damning case for the rating agencies."
October 20, 2000
