S&P says ratings changes to have more upgrades than downgrades.
Standard & Poor’s next week plans to finalize and apply its criteria on how it rates US corporates, the rating agency announced Wednesday. The agency said it made “meaningful but not substantive revisions” to the proposed criteria based on internal and external feedback.
“For a small group of issuers, the implementation of S&P’s new corporate criteria will result in a pleasant upgrade surprise; for a smaller group an unpleasant downgrade surprise,” said Thomas Bailey, head of ratings advisory at BNP Paribas. “For most, however, nothing changed and treasurers might be scratching their heads at this point wondering what all the fuss was about.”
Generally, because corporate ratings have been fairly accurate in predicting default risk, S&P said any changes to individual company ratings will be slight. “Global corporate ratings continue to perform well, so the new criteria will not significantly change our fundamental approach to credit analysis–and we expect ratings changes to be modest,” S&P said.
Of the new criteria, S&P said it expects:
- About 5 percent of our global ratings to change (about 200 issuer credit ratings will be affected by the criteria revision);
- Ratings changes to have an upward bias with upgrades outnumbering downgrades by a ratio of nearly 3:1;
- No sector, region, or ratings level to have a meaningful concentration of ratings changes; and
- Less than 10 percent of the ratings changes (fewer than 20 issuer credit ratings) to exceed one notch.
BNP’s Mr. Bailey said that while the new changes might not be a huge concern to corporates, S&P now has “a new, more structured approach to looking at corporate credits” with which they should get familiar. “Even for the 95 percent of issuers that did not see their ratings changed, it will be important for them to understand this new criteria,” he said. “What type of information they will need to present to S&P, and how to position themselves within these new rating factors. Issuers who effectively incorporate the new criteria into the dialogue with their lead analysts will likely benefit from greater financial flexibility and rating cushion.”
S&P said that when the new criteria are published, it will assign an “under criteria observation” (UCO) identifier to approximately 4,000 issuer credit ratings, indicating that the ratings are being reassessed due to new criteria. S&P noted that the UCO identifier doesn’t change the rating or its opinion of an issuer’s credit worthiness. The UCO identifier will remain until the conclusion of the review under the new criteria (reviews should take about five business days, S&P said), after which the issuer will be placed under S&P’s CreditWatch identifier. This means that a ratings change is possible. S&P also noted that not all issuers will be affected by the new criteria and thus won’t have a rating change. It said it will identify the issuer credit ratings that are unaffected.
Minor cash concerns
The agency said the latest criteria are revised from those released in July. This was a reflection of comprehensive testing, internal feedback and feedback from the public. In its summary of the industry feedback, S&P said its criteria for surplus cash garnered the most interest, mainly because many felt it unfairly punished companies with large cash balances. Thus they wanted more detail on how S&P arrived at this level. You can see the original June criteria proposals here.
“We received many questions and comments on our calculation of surplus cash, or the amount of cash and liquid investments we would subtract from gross debt to calculate debt,” S&P said in its summary of external feedback. “Respondents questioned all three adjustments we used to arrive at surplus cash but were most interested in receiving more detail around our rationale for choosing 25 percent as a haircut to reduce gross available cash. Many felt it unfairly punished companies with large cash balances and encouraged the use of bank lines.”
Other concerns regarding surplus cash, S&P said respondents generally felt its “peak intra-year working capital adjustment” was “overly restrictive and difficult to apply. Respondents also questioned S&P’s ability “to predict discretionary cash flow items such as acquisitions.” Commenters also wanted to know more about S&P’s treatment of overseas trapped cash “because of unfavorable tax implications.” S&P said many market participants also wanted to know if S&P’s ratio calculations “would change to reflect the new net debt basis and if ratio triggers for rating changes would be described in terms of net debt.”