Corporate financial professionals are questioning the accuracy and timeliness of credit ratings and believe the Securities and Exchange Commission (SEC) must take a more active role in promoting competition among the credit rating agencies, according to a new survey released today by the Association for Financial Professionals (AFP).
According to the survey, a third of financial professionals (34%) believe that their company's ratings are inaccurate, while only 42% believe changes in their organization's rating are made on a timely basis. The results of the new survey mirror those of an AFP survey conducted in 2002.
"Confidence in the credit rating process continues to be low among financial professionals," said Jim Kaitz, President and CEO of the AFP.
"Despite the headlines in the news over financial scandals and hearings in Congress, the situation has not improved. More than a decade ago the Securities and Exchange Commission (SEC) raised this issue and two years ago the SEC asked for comments on the credit rating process, yet they have failed to act to improve this function that is critical to global capital markets."
Concerns about accuracy and timeliness are shared both by organizations that have recently benefited from a ratings upgrade, and by organizations that have recently experienced a downgrade. More than a third (36%) of organizations that were recently upgraded believe that their ratings are inaccurate, while 48% believe that the ratings are not timely. Half (50%) of the organizations that recently received downgrades believe that their ratings are inaccurate, while 55% believe that the ratings are not timely.
In spite of these continuing concerns, credit ratings are an obligatory part of the process both for issuers and investors. Eighty-seven percent (87%) of survey respondents whose organizations issue debt indicated that credit providers require them to obtain and maintain a rating from at least one of the four nationally recognized statistical ratings agencies (NRSROs).
Further, only 9% of financial professionals believe that there would be no adverse impact on their organization or its investors if their organization ceased soliciting a rating from an agency with which the organization is dissatisfied.
In addition to being a critical part of the capital raising process, credit ratings are also important to organizations in making investment decisions and are used in other areas, such as the capital adequacy calculations for banks. The important role of credit ratings, along with the lack of competition in the market, is demonstrated in the rising cost of obtaining these ratings. One-in-five financial professionals (19%) indicated in the survey that the cost of obtaining a credit rating has increased at least 25% over the past three years, while 52% indicated that the costs of obtaining a credit rating has increased by at least 11% over the past three years.
At the same time, just over half (57%) of all financial professionals responded that they understand the methodologies used by the rating agencies, with 28% of survey respondents indicated that they do not understand the rating agency methodology. Further, about half of the survey respondents (49%) know how to appeal the rating their organization has been assigned, while 30% indicate that they do not understand how to appeal.
A third of respondents (32%) believe their organization's ratings are more reflective of the industry in which it operates than the organization's specific ability to service and repay debt. Thirty-nine percent (39%) believe the organization's industry plays a nearly equal role with the organization's finances in its rating, while 19% believe the organization's finances play the dominant role in determining its rating.
Financial professionals agree (59%) that the SEC should take a greater role in overseeing the credit ratings agencies. Among the key findings from respondents about oversight are:
- 59% believe the SEC should encourage greater competition among credit rating agencies -- including greater competition among the four current recognized agencies as well as possibly giving recognized status to other qualified rating agencies;
- 70% agree that the SEC should establish and clearly communicate the criteria necessary for a credit rating agency to achieve recognized status;
- 75% believe the SEC should review credit rating agencies after granting recognition to ensure that they continue to meet the recognition criteria;
- 91% percent believe the credit rating agencies should document the internal controls they have in place to protect against conflicts of interest; and
- 83% believe that regulators should require rating agencies to document and implement policies and procedures to prevent the disclosure of non-public information.
"Restoring issuer and investor confidence in the credit rating process is critical to global capital markets," concluded Kaitz. "Because credit ratings play a critical role in the capital markets, the Securities and Exchange Commission must become more actively involved to encourage greater competition among the credit rating agencies, foster innovation and oversee the process."
The 2004 Credit Rating Survey was conducted via e-mail in September 2004 to senior level financial professionals. The 2004 Credit Ratings Survey, in addition to the 2002 AFP Credit Rating survey, AFP's proposed Code of Standard Practices for Participants in the Credit Rating Process, and AFP's testimony on the subject, can be found on the AFP web site at the following address: www.afponline.org/press.