Very frequently, bond ratings agencies adjust their ratings for companies due to deliberate actions by the companies. For example, the company might take on a lot of new debt, or might increase dividend payouts, and increase the risk in the view of the rating agency. Or even if there’s improvement/deterioration in the business which results in the change, it could still be impacted by actions or non-action. E.g. if the company is less profitable, the company might forestall a downgrade by selling assets or cutting spending, and so on. My question is: to what extent to the bond ratings agencies tell the companies upfront “if you do/don’t do X, it will impact your rating in such-and-such manner?”
I would think a lot of companies would want to preserve or upgrade their ratings, and this would factor into their decision making. But are they just gambling based on a guess about what the agencies will do? Or do they have actual definitive knowledge?
For bond ratings of governmental bodies, the bond rating companies give a report with the ratings, that specifies why they raised/lowered the rating, and sometimes things they are ‘concerned’ about. (Plus you can get a more detailed report by paying for it.)
Those reports (and especially the ‘concerns’) are pretty broad hints of what the bond rating firm is thinking about. How you respond or fail to respond is very likely to affect your rating the next time you issue bonds.
I would presume ratings for commercial companies are similar.
They are pretty much the same as what you describe for government agencies. Furthermore, many times the agencies announce in advance that they are putting a firm on review for possible upgrade/downgrade.
Still, the question is if the companies can know that if they do X they will/won’t get an upgrade/downgrade. Because knowing exactly how far they can push the envelope would be a big deal for them if their ratings are important to them, and in theory I don’t see why the agencies wouldn’t inform them of this in advance.
There is also the technique of hiring the underwriting branch of the same company that does the bond ratings for your next stock/bond offering. It’s often said that doing so will help improve your bond ratings.
The bond rating companies deny this completely, of course.
I believe you may be confusing stock and bond ratings here.
The big three bond ratings agencies (S&P, Moodys, Fitch) don’t do underwriting, AFAIK. (However, they do get paid by the companies whose bonds they are rating, which could potentially lead to issues of that sort.)
I would find it hard to believe that it would be possible that some particular action would, in and of itself, warrant a change in bond rating so long as it has been some time since the rating was last reviewed. It might mean that on the balance of things it would tend to push the risk of default such that the rating would need to be lowered, but other things may have improved in the company such that in general they are more financially stable and the one particular action combined with such improvement leaves them at the same place they were before.
I was looking over some bonds with a client today for a major bank and it went to ‘Downgrade Watch’ - which means it’s a possible downgrade but not certain - as we reviewed them. Not a happy time.
The rating companies are paid by the companies they rate. You need the rating to sell your (bonds etc). It’s like paying for a “Kosher”, “Halal” or “Organic” rating.
Yes, this does create a conflict of interest.
I imagine that there are other customers who also pay for independent ratings, but I haven’t heard of such.
In this case, the issue is that the company is a jumble of interlocked partnership entities, which would be better served by combining into one entity. What’s holding it up is that the combined debt leverage would be enough to cause them to lose their investment grade debt rating. So they’re waiting until the debt rating agencies give them “the green light”, i.e. tell them that their metrics are now such that they won’t lose investment grade rating by rolling up the company.
Negotiating the rating is a bit of a misnomer. If Company A has an existing credit rating with Rating Agency A, and Company A’s performance has been declining and the Rating Agency believes that the Company’s credit risk is rising to the point that their rating should be downgraded, yes the Rating Agency will privately notify the Company that they are going to publicly put their rating on “Watch”. A “watch” notification signifies to the public that Company’s rating is going under review and most likely to be downgraded. The Company can request to meet with the Rating Agency to plead their case and present new information that may change the Rating Agency’s opinion. This isn’t a negotiation, but rather presenting the Rating Agency with all of the facts and information to allow them to draw complete conclusions.
Now in the case where Company B doesn’t have an existing credit rating but is getting ready to issue new debt which needs to be rated, they can engage Rating Agency A to conduct a “rating advisory service” (RAS). A RAS is typically where Company B will provide information about their company, their new debt, financial forecasts, etc. The Rating Agency will provide a private indicative rating and may include ratings for various scenarios. Company B will pay Rating Agency A for this service. If Company A doesn’t like the indicative ratings they try another Rating Agency, like Rating Agency B or C and do the RAS over again. This is called shopping for a rating.
Understood. But neither of these relate to the scenario being discussed in the OP.
The question was: "to what extent to the bond ratings agencies tell the companies upfront “if you do/don’t do X, it will impact your rating in such-and-such manner?”
In the case of the company cited in my prior post, X is a rollup of the interconnected companies into one company. My question would be whether the rating agencies do the analysis upfront such that they can tell the company what the impact would be on their rating if they took that action, or if they waited for the company to take the action before making that determination. Based on the quotes from the earnings call, it would seem that the former is correct.
I’ll somewhat reiterate and slightly expand what I said last time I posted in this thread. There is no one particular action that a company can take that will improve its credit rating. Its credit rating is the combined financial assessment of a ratings agency based on the company’s track record and the current economic environment. What will improve the credit rating is a series of good quarterly reports showing good debt coverage ratios and not taking on any new debt. Deciding a pay down a loan with free cash very well may cause the credit rating to fall even if it means they lower their debt ratio, since it gives them less slack to handle crises and if they’re forced to borrow again in the short-term it would have been much better to not pay down the debt to begin with (depending on the terms of the debt they repaid). Any other individual action that I can think of would only be an attempt to improve earnings and/or other ratios that the debt agencies are looking at, and it would take a quarter or more to see if their decision has led to the intended improvement.
This is not correct. Anyone who follows these matters will have encountered instances where credit agencies take action (one way of the other) based on one particular action. There is also no logical reason for your assertion to be correct.
Of course, it would have to be a significant action. But companies undertake significant actions all the time.
Possible ratings actions ‘discussed’ upfront: definitely, as several posts have noted. Rating agencies don’t have any policy of avoiding private communication with their customers, who are the companies/entities being rated.
‘Negotiation’ is more fuzzy. What most people would call negotiation is more likely in either the example given of a restructuring, or more infamously wrt to the 2008/9 financial crisis, the ratings of synthetic entities such as the ratings of various pieces or ‘tranches’ of collateralized bond obligations. There’s extensive back and forth seeking to determine the exact structure of the deal which gives the highest yield to investors in the various pieces for the highest rating or a given rating the underwriting is seeking for them. I think it would be quibbling to say that’s not a ‘negotiation’.
For ‘organic’ companies whose ratings might change with the normal ebb and flow of business there’s less to ‘negotiate’. It’s a matter of determining the rating agency’s position. As some posts have suggested, it would be a less efficient system if companies had to do things first to see the ratings effect without any prior sense of what it might be. OTOH the agencies are sensitive about being accused of inserting themselves into management decisions. That even goes for the synthetic entity case. There’s a lot of ‘it’s up to you but our general sense of this is X’.
I wouldn’t have thought they would avoid communication. But there’s a lot of analysis which goes into these ratings determinations, and the agencies would have to do them upfront, for a contemplated action which may not end up taking place for other reasons, in order to give an answer in advance.
But also, the question is whether the companies get to try to convince the agencies that they should be rated higher, or whether they just provide financial information and then step back and let the agencies do their thing.
When I’m thinking of “negotiation” it’s not as if the companies have any bargaining chips, so it’s not in that sense. I was thinking more of an extended give-and-take, where the company suggests structuring things one way or the other in order to get/keep a higher rating. “How about if we make the acquisition using $X in debt and issue $Y in equity? You could make a case that such-and-such ratio is still acceptable. No? OK, then how about if we replace $Z of the debt with preferred shares? That should be considered equity and not debt …”. And so on.