As presented on a SII CPD Seminar on 2 July 2009 in London - an updated version of the "Risk of Over-reliance on Ratings" presentation but with new slides and incorporated participants\' responses.

1. RATING AGENCIES – Q&A
The Risk of Over-reliance on Ratings
Markus Krebsz, MSI
SII CPD Seminar, London – 2 July 2009

2. CONTENT
• Overview
• Ratings
• Application
• Constructive criticism
• Risks/Mitigants
• Questions & close
2

3. OVERVIEW

4. QWIZDOM SURVEY
As part of this interactive workshop session
• We asked 50 seminar attendees
• to answer seven topical questions
• and to submit their answers via each participants’
• Qwizdom unit
The following pages
• Illustrate for each question
• the audience’s response
• Indicated by the Qwizdom symbol:
4

5. QUESTION 1:
Do you use Rating agencies and if so, how?
(A) I do not use them
(B) Once a day (C) Once a week
or more or more A
24%
D
44%
B
16%
C
(D) I do, but only infrequently 16%
5

6. QUESTION 2:
How many (Credit) rating agencies exist globally?
(A) 3 to 5
A
10%
(B) 6 to 15 (C) 16 to 30 B
13%
D
52%
C
(D) More than 30 25%
6

7. 1) A.M. Best Company, Inc. 33) Islamic International Rating Agency, B.S.C. (IIRA)
2) Agusto & Co. Ltd. 34) Japan Credit Rating Agency, Ltd. (JCR)
3) Ahbor Rating 35) JCR-VIS Credit Rating Co. Ltd.
4) Apoyo & Asociados Internacionales S.A.C. 36) Korea Investors Service, Inc. (KIS)
5) Bank Watch Ratings S.A. 37) Korea Ratings Corporation
6) BRC Investor Services S.A. 38) Lanka Rating Agency, Ltd. (LRA)
7) Calificadora de Riesgo, PCA 39) Malaysian Rating Corporation Berhad (MARC)
8) Capital Intelligence, Ltd. 40) Mikuni & Co., Ltd.
9) Caribbean Information & Credit Rating Services Ltd. (CariCRIS) 41) Moody's Investors Service
10) Central European Rating Agency (CERA) 42) National Information & Credit Evaluation, Inc. (NICE)
11) Chengxin International Credit Rating Co., Ltd. 43) ONICRA Credit Rating Agency of India, Ltd.
12) China Lianhe Credit Rating, Co. Ltd. 44) P.T. Kasnic Credit Rating Indonesia -- Indonesia
13) Clasificadora de Riesgo Humphreys, Ltda. 45) P.T. PEFINDO Credit Rating Indonesia
14) Class y Asociados S.A. Clasificadora de Riesgo 46) Pacific Credit Rating (PCR)
15) CMC International, Ltd. 47) Pakistan Credit Rating Agency, Ltd. (PACRA)
16) Companhia Portuguesa de Rating, SA (CPR) 48) Philippine Rating Services, Corp. (PhilRatings)
17) Credit Analysis & Research Ltd (CARE) 49) RAM Rating Services Berhad (RAM)
18) Credit Rating Agency of Bangladesh, Ltd. (CRAB) 50) Rapid Ratings International, Inc.
19) Credit Rating Information and Services, Ltd. (CRISL) 51) Rating and Investment Information, Inc. (R&I)
20) CRISIL, Ltd. 52) Rus Ratings
21) Dagong Global Credit Rating Co., Ltd. 53) Seoul Credit Rating & Information, Inc.
22) Dominion Bond Rating Service (DBRS) 54) Shanghai Credit Information Services Co., Ltd.
23) Duff & Phelps de Colombia, S.A., S.C.V 55) Shanghai Far East Credit Rating Co., Ltd.
24) Ecuability, SA 56) Slovak Rating Agency, a.s. (SRA)
25) Egan-Jones Rating Company 57) SME Rating Agency of India Limited (SMERA)
26) Equilibrium Clasificadora de Riesgo 58) Sociedad Calificadora de Riesgo Centroamericana, S.A. (SCRiesgo)
27) European Rating Agency (ERA) 59) Standard and Poors (S&P)
28) Feller Rate Clasificadora de Riesgo 60) Taiwan Ratings, Corp. (TCR)
29) Fitch Ratings, Ltd. 61) Thai Rating and Information Services Co., Ltd. (TRIS)
30) Global Credit Rating Co. 62) TheStreet.com Ratings, Inc.
31) Interfax Rating Agency (IRA) 63) Türk KrediRating (TCRating)
32) Investment Information and Credit Rating Agency (ICRA) 64) Veribanc, Inc.
Source: www.defaultrisk.com 7

8. QUESTION 3:
AAA (Fitch) = AAA (S&P) = Aaa (Moody’s)?
YES NO
32% 68%
8

9. RATING PRINCIPLES
Fitch Ratings, Standard & Poor’s:
Probability of default (PD) = First dollar of loss
What is the ultimate default risk?
Moody’s:
Expected loss (EL) = [(PD) X (LGD)]
What is the amount of net loss suffered?
9

10. Y
QUESTION 4:
D (Fitch) = D (S&P) = D (Moody’s)?
YES NO
47% 53%
10

11. RATINGS MAPPING TABLE
Fitch Ratings Moody’s Standard & Poors Mapped
Long-term rating Short-term rating Long-term rating Short-term rating Long-term rating Short-term rating internal
r a t i n g
Investment Grade
AAA Aaa AAA iAAA
AA+ F1+ Aa1 AA+ iAA+
A-1+
AA Aa2 P1 AA iAA
AA- Aa3 AA- iAA-
F1+ or F1
A+ A1 A+ A-1 iA+
A F1 A2 P-1 or P-2 A A-1 or A-2 iA
A- F1 or F2 A3 A- iA-
P-2 A-2
BBB+ F2 Baa1 BBB+ iBBB+
BBB F2 or F3 Baa2 P-2 or P-3 BBB A-2 or A-3 iBBB
BBB- F3 Baa3 P-3 BBB- A-3 iBBB-
BB+ Ba1 BB+ iBB+
BB B Ba2 BB iBB
Speculative Grade
B
BB- Ba3 BB- iBB-
Ranges within
B+ B1 B+ iB+
B-1, B-2 and B-3
B B2 B iB
B- B3 Not Prime B- iB-
CCC+ Caa1 CCC+ iCCC+
C
CCC Caa2 CCC iCCC
CCC- Caa3 CCC- C iCCC-
CC Ca CC iCC
C C C iC
DDD, DD, D D
Moody’s: D D D iD
Source: Bloomberg, Fitch, Moody’s and S&P 11

12. QUESTION 5:
SF Bond 1 rated AAA (Fitch/ S&P/ Moody’s)
= SF Bond 2 rated AAA (Fitch/ S&P/ Moody’s)?
YES NO
13% 87%
12

13. SUPER-SENIOR RATINGS
Structure 1 Structure 2
Tranche 1: AAA Tranche 1: AAA AA
Tranche 2: AA+ Tranche 2: AAA A
Tranche 3: A Tranche 3: AAA
Tranche 4: BBB- Tranche 4: AA+
Tranche 5: BB Tranche 5: A
Tranche 6: B+ Tranche 6: BBB-
First Loss piece: NR Tranche 7: BB
Tranche 8 B+
First Loss piece: NR
13

14. RATINGS

15. QUESTION 6:
How would you define ‘rating’?
(A) Opinion
(B) Benchmark (C) Benchmark
measure measure A
for PD AAA for LGD D 25%
41%
B
C 31%
3%
(D) View not necessarily based on facts or knowledge
15

16. RATING DEFINITION
• An opinion… * [Financial journalists]
• …on the relative ability…
• …of an entity to meet financial commitments.
*
‹ä|xã ÇÉà ÇxvxáátÜ|Äç utáxw ÉÇ ytvà ÉÜ ~ÇÉãÄxwzx
Ratings are benchmark measures of…
• Probability of default (PD)
• Expectations of Loss given default (LGD)
16

17. RATINGS…
…can capture: …do NOT capture:
• Credit risk Market risk
Liquidity risk
Operational risk
Basis risk (IR risk)
…and are “hard-wired”…
• by Basel II
• into banks’ credit rating models
• Investment guidelines and Asset management mandates 17

18. STATISTICAL: Probability of Default
30%
1-year PD
25%
20%
15% Moodys
S&P
10%
Fitch
5%
0%
AA+
AA-
A+
A-
BB+
BB-
BBB
B
A
BBB+
BBB-
B+
B-
AAA
AA
BB
CCC/C
AA
BB
BBB
80%
10-year PD
70%
60%
50%
40% Moodys
30% S&P
20% Fitch
10%
0%
AA+
AA-
A+
A-
BB+
BB-
BBB
B
A
BBB+
BBB-
B+
B-
AAA
AA
BB
CCC/C
Source: Fitch Ratings 18

19. RATINGS SCOPE
• Public
• Private
• Credit assessment
• Market-Implied ratings
(CDS, Equity, Spread, Price etc.)
19

20. RATING ACTIONS
Rating Suffix
DEAL STAGE RATING WATCH
• Preliminary • Positive
• Final • Negative
• Paid in Full (PIF) / • Evolving / Uncertain
Redemption
OUTLOOK
INDICATORS • Positive
• Upgrade, Downgrade • Negative
• Affirmation / Confirmation • Stable
• Withdrawn
20

21. APPLICATION

22. RATINGS are used by …
Banks, Other Financial Institutions, Originators & Issuers,
Investors, Financial Regulators, Other Rating agencies, etc. …
in order to …
• Outsource analysis
• Determine required economic and regulatory capital charges
• Manage individual credit & portfolio risks
• Feature as input into Structured Finance models (CDO2 etc.)
22

23. CONSTRUCTIVE CRITICISM

24. FAILURES
AIG, Bear Stearns, Bradford & Bingley, Enron, Icelandic banks,
Lehman Bros., Monolines, Northern Rock, Parmalat, etc.
In their own words...
Fitch: “… did not foresee the magnitude of the decline…or the
dramatic shift in borrower behavior…”
Moody’s: “We did not . . . anticipate the magnitude and speed
of the deterioration in mortgage quality or the suddenness of
the transition to restrictive lending.”
S&P: “it is now clear that a number of assumptions used in
preparing ratings on mortgage-backed securities issued
between 2005 and mid-2007 did not work.”
Source: US Government Oversight and Reform Committee, Oct 2008
24

25. CRITICISM
• Business model: Too slow to react
• Assumptions, methodologies & models
• Conflict of interest (“issuer-pays” model)
• Limited capture
• Split ratings
• Notching
• Implied ratings & internal competition
• etc.
25

26. THE RISKS OF OVER-RELIANCE
- AND SUITABLE MITIGANTS

27. TIMELY ACTIONS and DEFERRAL
Rating process: Rating scope vs. time:
Timeliness of Rating changes Bond maturity profile
• Process stages to reach • Legal final vs. expected final
rating decisions maturity
• Detection of bond- vs. • Life-time ratings (40+ years)
asset class-specific • Timely payment of interest
and/or systemic issues & ultimate payment of
principal
27

28. TIMELAG of RATING ACTIONS
Number of Global SF Bond Downgrades
by CRA
190,000
180,000
170,000 176,046
160,000
150,000
TOTAL S&P Moody's Fitch
140,000
130,000
120,000
110,000
111,605
100,000
90,000
80,000
70,000
60,000 68,372
50,000
49,594 50,968
40,000 47,510
30,000
20,000
30,749
7,992
10,000 2,042
1,166
0
1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09
(Since January 2007 - Source: Bloomberg)
28

29. Regional problem GLOBAL IMPACT
Number of Global SF Bond Downgrades
by Region
190,000
180,000
170,000 175,208
160,000
150,000
TOTAL Europe US
140,000
130,000
120,000
110,000
111,239
100,000
90,000
80,000
70,000
60,000 68,073
50,000
40,000 49,160 50,676 47,284
30,000
20,000
30,597
7,981
10,000 2,035
1,161
0
1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09
(Since January 2007 - Source: Bloomberg)
29

30. OPERATIONAL RISKS
• Changing methodologies and assumptions
• Timeliness of rating decisions
• Model risks
• Striking the right balance between non- and
over-regulation
30

31. RISK MITIGANTS
• Understanding the meaning of ratings
• Understanding instruments’ risks
• Independent analysis
• Internal ratings
• Disputing rating decisions and methodologies
with the agencies – is it really worth it?
• Operational risk scenario: Awareness that
agencies CAN and DO get their ratings wrong
31

32. QUESTIONS & CLOSE
32

33. QUESTION 7:
Would you now give CRAs more or less credit ?
More
Less
Less More
70% 30%
33

34. CONTACT
Markus Krebsz
+44 (0) 79 85 065 045
krebsz@web.de
markus.krebsz@4-most.co.uk
4most
Linen Hall
162-168 Regents Street
London, W1B 5TE
Tel. +44 (0) 207 038 3690
www.4-most.co.uk

35. ANNEX: Ratings & Probability of Default (PD)
1 year 5 year 10 year
Moodys S&P Fitch Moodys S&P Fitch Moodys S&P Fitch
Aaa 0.00% AAA 0.00% 0.00% Aaa 0.18% AAA 0.10% 0.11% Aaa 0.40% AAA 0.45% 0.37%
Aa1 0.00% AA+ 0.00% 0.00% Aa1 0.15% AA+ 0.16% 0.11% Aa1 0.25% AA+ 0.34% 0.47%
Aa2 0.00% AA 0.00% 0.00% Aa2 0.28% AA 0.15% 0.14% Aa2 0.67% AA 0.77% 0.68%
Aa3 0.00% AA- 0.02% 0.01% Aa3 0.18% AA- 0.52% 0.25% Aa3 0.33% AA- 1.11% 0.91%
A1 0.00% A+ 0.05% 0.02% A1 0.38% A+ 0.64% 0.41% A1 0.84% A+ 1.68% 1.30%
A2 0.03% A 0.04% 0.04% A2 0.68% A 0.42% 0.57% A2 1.69% A 1.80% 1.78%
A3 0.03% A- 0.04% 0.04% A3 0.65% A- 0.86% 0.75% A3 1.69% A- 2.44% 1.91%
Baa1 0.17% BBB+ 0.22% 0.22% Baa1 1.46% BBB+ 2.30% 1.82% Baa1 2.31% BBB+ 4.65% 3.82%
Baa2 0.12% BBB 0.28% 0.21% Baa2 2.11% BBB 2.17% 2.14% Baa2 5.49% BBB 5.27% 5.61%
Baa3 0.41% BBB- 0.39% 0.42% Baa3 3.60% BBB- 4.94% 4.03% Baa3 7.20% BBB- 8.97% 8.23%
Ba1 0.66% BB+ 0.56% 0.63% Ba1 6.76% BB+ 6.47% 6.19% Ba1 12.38% BB+ 11.74% 12.25%
Ba2 0.62% BB 0.95% 0.90% Ba2 8.82% BB 9.98% 8.37% Ba2 14.66% BB 17.34% 17.08%
Ba3 2.23% BB- 1.76% 2.05% Ba3 19.14% BB- 15.03% 15.92% Ba3 36.24% BB- 24.97% 30.27%
B1 3.03% B+ 3.01% 3.10% B1 25.27% B+ 20.86% 21.53% B1 47.43% B+ 30.15% 38.18%
B2 5.93% B 8.34% 7.24% B2 31.24% B 29.44% 27.84% B2 44.48% B 36.29% 41.06%
B3 10.77% B- 12.15% 11.71% B3 43.55% B- 37.71% 39.23% B3 62.32% B- 45.05% 53.69%
Caa-C 22.24% CCC/C 28.83% 25.54% Caa-C 60.40% CCC/C 50.85% 53.55% Caa-C 78.81% CCC/C 56.45% 65.07%
35