Like many of the credits it evaluates, Fitch Ratings is looking for an upgrade. To its own rating systems, that is.
Moody's Investors Service, meanwhile, plans to release its own default study this summer, but the outlook for its rating criteria remains stable.
Fitch is working on various projects that it hopes will enhance its ability to rate below-investment grade debt and improve rating consistency in all sectors, according to Frank Rizzo, the agency's managing director of public finance.
Building on its 1999 default study, Fitch is going one step further by trying to evaluate the likelihood that an investor will get fully paid in the event of a default.
Some bonds have characteristics that increase the probability that an investor will recover 100 cents on the dollar even in a default, Rizzo said in a recent interview.
'With non-investment grade deals, most people just throw it all in the garbage can and say it's all junk,' he said. 'There might be some BB-rated bonds that are consistent with certain people's risk appetite.'
By way of comparison, according to Fitch's 1999 survey, corporate bonds rated in the A category or higher have a 1% or less chance of defaulting, BBB bonds have a 3% chance, BB-rated bonds have an 18% chance, and B-rated bonds have a 36% chance.
Fitch has already started including some notion of ultimate recovery in some of its rating reports. When rating Colorado Public Radio earlier this year, it found that the station's licensing rights are extremely valuable and probably could protect investors completely, Rizzo said.
'It didn't change the rating above a BBB-plus ... but if we had this system in place maybe we could have factored it into the rating,' he said.
Besides including such information in reports, over the next six to eight months Fitch will explore the possibility of including some notion of ultimate recovery in the ratings.
'We'll go that way if it doesn't confuse the market,' Rizzo said. Recovery information may be more feasible and useful in certain market sectors. The agency may also develop a separate indicator for recovery, such as a numeric scale, he said.
Besides challenging its analysts in new ways, the ongoing project also presents an untapped business opportunity, according to Rizzo.
'Our business motivation for the ultimate recovery study comes from a desire to get more business in non-investment grade municipal ratings. It's not a market we can usually play in,' he added, since most non-investment grade debt sells without public ratings.
Moody's default study, which is to be released later this summer, will also discuss ultimate recovery, the firm said in a special comment. The study found municipal bonds that have defaulted recover more on average than corporate bonds and have a higher probability of greater recovery.
Fitch is also experimenting with a model that could capture the collective thinking of the organization to standardize the rating process, Rizzo said.
Researchers at the Maxwell School of Syracuse University created a system they dub 'artificial intelligence' that analyzes all the financial numbers, ratios, operating statistics, and other credit factors 'and should derive a rating with a high probability of accuracy,' he said. 'If it works, we think it helps us in the process of making ratings more predictive instead of a lagging indicator, improve rating consistency, and provide more information to demystify the rating process.'
As a test case, Fitch is working with the university to develop a model for the revenue-backed airport sector, which should be easier than creating a model for a tax-backed sector, Rizzo said. He hopes to see by the end of this year if the model works for that sector.
Finally, Fitch next year plans to update its 1999 default study -- which covered all bonds issued between 1979 and 1986, and all municipal defaults between 1980 and 1999 -- by adding in three more years of data, Rizzo said at the 4th Institutional Investors Conference on California Redevelopment Financing in Culver City earlier this month. Besides noting any changes in ratings or the agency's criteria, the report may discuss how much ratings went up or down over time even if the bonds didn't default. It may also try to break out default ratios for more individual sectors, such as health care and redevelopment bonds, he said.
Moody's default study spans the years from 1970 to 2000 and covers 82,000 ratings for nearly 29,000 separate credits that Moody's has rated, according to Lisa Washburn, senior credit officer. Over 30 the years, only 18 of them defaulted, she said. About half of the defaults occurred in the health care sector.
Moody's chose not to analyze unrated debt. Anecdotally, analysts know of about 700 defaults of such credits during that time period, Washburn said.
'There isn't a way for us to model default rates outside of the Moody's database with any degree of accuracy,' she said.
Moody's surveyed investors and other market participants and found that though the study shows most municipal ratings could rise to be consistent with the corporate rating scale, 'the vast majority valued the rating system as more than just default probability,' Washburn said.
'We don't anticipate making any major changes to our rating scale,' she said. 'You'd think people would like to see all the ratings raised, but they didn't. We've been told there is value in the scale as it exists to discriminate among credits.'
The study will also address the comparability between municipal ratings and ratings in other sectors, such as corporate debt.
'We're looking to provide some general guidance as to where credits would be in other sectors,' Washburn said. However, direct comparisons will always be difficult between corporations and government credits because of certain differences, such as the ability to raise taxes or fees and obligation to provide a service.
Private intermediaries, such as investment bankers, expressed the most interest in such comparisons, to better enable them to manage risks, according to Washburn.
Standard & Poor's completed its own default study last summer, but 'the default study is not driving criteria changes for us,' said Colleen Woodell, a managing director. The agency reviews its criteria on an ongoing basis and makes revisions when needed, she said. It doesn't have any major studies in the works right now, but periodically releases sector-specific reports.
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