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Capital Markets

Fitch Revamps Short-Term Debt Ratings Methodology

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April 15, 2019

Some CP programs will see downgrades but issuer control increases. 

Bond3A new short-term-debt ratings methodology recently launched by Fitch Ratings may result in both pleasant and unpleasant surprises for some corporate issuers. Nonetheless, the methodology aims to give all issuers more transparency into the ratings process and more grounds to argue their case. 

More power to the corporate. “A key change is that now [the short-term rating] is something you can debate with the agency,” said Richard Hunter, global head of corporate ratings at Fitch. He added that the rating agencies have traditionally slotted corporates into F1, F2 or the lowest F3 short-term rating depending on where their long-term ratings lie. The rationale generally was that the one-year default risk between debt rated A- and BBB+ essentially immeasurable, and so they both got an F2 rating.  “That bucketing argument was rather simplistic,” Mr. Hunter said. “A company with particularly strong liquidity but a lower long-term rating was pretty much stuck in the short-term bucket assigned to it by that rating.”

Short-term ratings move away from “grid.” Fitch now has developed a methodology to analyze the short-term liquidity position of a company or financial institution in more detail and compare it to peers. In doing so, it decided to allow for some overlaps, so whereas the default short-term rating for a company with long-term debt rated A- was F2, now if its liquidity position is strong its commercial paper (CP) may be rated F1. Similarly, a company with a long-term debt rating of BBB that has less short-term liquidity may be moved from the F2 default rating down to F3, a marginal market that could result in some issuers losing access to CP.

Before this, treasurers were largely forced to determine their short-term ratings by reading a grid, the approach the other rating agencies still take, Mr. Hunter said. He added that the agencies nominally provided some flexibility, but it was minimal and inconsistent. “In the past, borrowers would look at the agencies’ criteria and say, ‘I can’t really argue with your grid. But now we’re looking at factors the company could in theory address, such as by changing its cash position, or addressing any FX mismatches, or making a public declaration about the company’s financial policy,” he said. 

More up than down. Mr. Hunter said that companies looking strong from a short-term perspective may actually be stockpiling cash to make acquisitions when looked at more closely. “We want to make sure we do put someone in a certain short-term category because they have a big M&A war chest and then, when that war chest is spent on acquisitions, have to change the rating,” Mr. Hunter said. Under the new methodology finance executives can quickly gauge where their companies’ stand in terms of those factors by looking at criteria Fitch already publishes in its Navigators charts, he added.

Mr. Hunter said Fitch estimates 20% of its 800 corporate short-term ratings, or 160, will change. Of that number, about two thirds will move up and the rest will move down, although their long-term ratings will remain at the BBB level. 

 

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