understanding_ratings

Understanding Ratings

The GCR ratings framework is a transparent, quantifiable and comparable credit ratings system. It is applicable for all corporate, financial institution, insurance and public sector ratings. It is not directly applicable for Structured Finance ratings, whose criteria and methodology can be accessed by clicking here.

The new GCR ratings framework is based on a numerical scoring system, between 0 (weakest) and 40 (strongest). Each rated entity’s major rating components, namely the Operating Environment, the Business Profile, the Financial Profile and the Support & Peer Comparison components, will be scored using specific methodologies and assumptions (which can be accessed here). The four GCR Rating framework components do not have any predefined weightings. Therefore, anyone component could be the driving force behind a rating. As a result, the accumulation of the component scores will equal the GCR Risk Score. All scores will be made public upon the release of the rating so the user can determine the specific strengths and weaknesses of a rated entity and how this might change issuer and issue ratings over time. The lower the score, the weaker the assessment.

Once we have established the GCR risk score we will use the GCR Anchor Credit Evaluator (a dynamic mapping table, anchored in the country risk score of each jurisdiction) to assign the, lower-case letter, GCR anchor credit evaluation (ACE). The ACE is not an issuer credit rating, rather it is a theoretical ‘analytical entity’ rating, off which we can drive a number of legal entity issuer credit ratings. See below for the difference between the ‘analytical entity’ and the ‘rated entity’. Having established the ACE for the ‘analytical entity’, we can apply the final Rating Adjustment Factors to finalize the rating(s) on the ‘rated entity’. It is important to remember that issuer credit ratings can only be accorded to legal entities.

For a full understanding of GCR’s Rating Framework, please click on the icon above.

The Anchor Credit Evaluator is a mapping table, which links the GCR Risk score to our issue(r) credit ratings. It can be used by looking up the GCR risk score, finding the appropriate international and / or national scale rating columns and drawing an interlocking line between the two points of reference. For example, a GCR risk score of 10 would map to an International scale b, and a South Africa scale bb/bb-, and a Kenyan scale a+/aa-. These lower-case scale ratings are the anchor credit evaluation (ACE), this is the abstract rating on the analytical entity (See rating definitions for more information). The ACE can be then refined through the structural and instrument rating adjustment factors to create the issue(r) credit ratings of a rated entity.

The Anchor Credit Evaluator has been designed for two purposes. Firstly, to allow for improved transparency regarding how GCR ratings are created, via the GCR risk score. Secondly, to allow for a change in country risk conditions to be reflected in the international scale ratings but not (necessarily) in the national scale ratings. This has been achieved by linking the b- national scale rating to the country risk score. Typically, when a country risk score changes, we will make a parallel move with that jurisdictions mapping table. For example, an improvement in the Ghanaian country risk score could lead to movement from bucket 4 to bucket 5.

Simultaneously, all Ghanaian entities could have an improvement in the underlying GCR risk score, all else being equal. This could lead to an improved international scale rating but no change in the national scale ratings. This is important because national scale ratings are meant to, some extent, negate country and sovereign risk. We have mapping two options per country risk score, to achieve a better distribution of the ratings and the movement in the country risk score.

Introduction

GCR accord ratings on an international rating scale and a diverse number of national rating scales. These include credit ratings such as Long and Short-Term issuer and issue Ratings, Financial Strength Ratings and Structured Finance ratings. They also include ‘non-credit’ ratings such as servicer quality ratings, asset manager management quality ratings and funds ratings.

The guide below has been created to improve the understanding of GCR’s rating scales, symbols and definitions. This guide, alongside the GCR Ratings Framework, aims to enhance transparency and comparability of our ratings and therefore should be read in conjunction with the Criteria for GCR Ratings Framework’ document.

Please click on the icon to download the Ratings, Scales, Symbols and Definitions Guide

The Credit Rating Process

GCR Ratings

Primary Analyst: Matthew Pirnie, Johannesburg, matthewp@GCRratings.com

Secondary contacts: Marc Chadwick, Johannesburg, chadwick@GCRratings.com

  1. FAQ: Please explain how the new GCR criteria framework works?
  2. The GCR ratings framework is a transparent, quantifiable and comparable credit ratings system. It is applicable for all corporate, financial institution, insurance and public sector ratings. It is not directly applicable for Structured Finance ratings, whose criteria and methodology can be accessed by clicking here.

    The new GCR ratings framework is based on a numerical scoring system, between 0 (weakest) and +40 (strongest). Each rated entity’s major rating components, namely the Operating Environment, the Business Profile, the Financial Profile and the Support & Peer Comparison components, will be scored using specific methodologies and assumptions (which can be accessed here). The four GCR Rating framework components do not have any predefined weightings. Therefore, anyone component could be the driving force behind a rating. As a result, the accumulation of the component scores will equal the GCR Risk Score. All component scores will be made public upon the release of the rating so the user can determine the specific strengths and weaknesses of a rated entity and how this might change issuer and issue ratings over time. The lower the score, the weaker the assessment.

    Once we have established the GCR risk score we will use the GCR Anchor Credit Evaluator (a dynamic mapping table, anchored in the country risk score of each jurisdiction) to assign the, lower-case letter, GCR anchor credit evaluation (ACE). The ACE is not an issuer credit rating, rather it is a theoretical ‘analytical entity’ rating, off which we can drive a number of legal entity issuer credit ratings. See below for the difference between the ‘analytical entity’ and the ‘rated entity’. Having established the ACE for the ‘analytical entity’, we can apply the final Rating Adjustment Factors on a ratings scale basis to finalize the rating(s) on the ‘rated entity’. This allows for ratings differential for organizational and creditor hierarchy on both a national and international rating scale basis, allowing for more accurate representations of relative risk. It is important to remember that issuer credit ratings can only be accorded to legal entities.

  3. FAQ: What is the GCR Anchor Credit Evaluator and how does it work?
  4. The Anchor Credit Evaluator is a mapping table, which links the GCR Risk score to our issue(r) credit ratings. It can be used by looking up the GCR risk score, finding the appropriate international and / or national scale rating columns and drawing an interlocking line between the two points of reference. For example, a GCR risk score of 10 may map to an International scale b, and a South Africa scale bb/bb-, and a Kenyan scale a+/aa-. These lower-case scale ratings are the anchor credit evaluation (ACE), this is the hypothetical rating on the analytical entity (See rating definitions for more information). The ACE can be then refined through the structural and instrument rating adjustment factors to create the issue(r) credit ratings of a rated entity on a rating scale basis.

    The Anchor Credit Evaluator has two purposes. Firstly, to allow for improved transparency regarding how GCR ratings are assigned and transition, via the GCR risk score. Secondly, to allow for a change in country risk conditions to be reflected in the international scale ratings but not (necessarily) in the national scale ratings. This has been achieved by linking the b- national scale rating to the country risk score. Typically, when a country risk score changes, we will make a parallel move with that jurisdictions mapping table. For example, an improvement in the country ‘x’ risk score could lead to movement from bucket 4 to bucket 5. Simultaneously, all entities operating in ‘X’ could have an improvement in the underlying GCR risk score, all else being equal. This could lead to an improved international scale rating but no change in the national scale ratings because the mapping moves in parallel. This is important because national scale ratings are meant to, some extent, negate country and sovereign risk. We have mapping two options per country risk score, to achieve a better distribution of the ratings and the movement in the country risk score.

  5. FAQ: What are the Rating Adjustment Factors and how do they work?
  6. The Rating Adjustment Factors make alterations on a ratings scale basis (from the ACE) for structural/ organizational and regulatory factors for issuer credit ratings. We make these adjustments on a rating scale basis, instead of the risk scoring basis, to allow us to create our view of the most ‘correct’ credit hierarchy, within a group. Similarly, we will adjust instruments (issue ratings) on a rating scale basis, factoring in contractual/ statutory subordination or default characteristics of the notes. Importantly, the issuer credit rating is typically meant to be reflective of its senior unsecured credit strength.

  7. FAQ: What is the difference between the ‘analytical entity’ and the ‘rated entity’?
  8. While GCR assigns ratings exclusively to legal entities/ obligations, the creditworthiness of that entity or obligation is often based on, or supported by, the financial and corporate strengths of its immediate group or parent (excluding structured finance ratings). The legal entity that has or will be assigned an issuer credit rating is the ‘rated entity’.

    We use the ‘analytical entity’ term to assign a theoretical group rating, off which a number of legal entity ratings can be subsequently assigned or supported. In some cases, the ‘analytical entity’ maybe a whole consolidated group, in others it could be a part of a consolidated group or even a standalone legal entity.

    The GCR Anchor Credit Evaluation, illustrated as a lower-case rating, will refer exclusively to the ‘analytical entity’. In order to refine the ‘rated entity’ ratings, GCR go through the rating adjustment factors detailed above.

  9. FAQ: If GCR do not rate sovereigns, how does the company ensure that it captures the sovereign and country risks for its ratings universe?
  10. Whilst GCR do not rate sovereigns we do capture country risk and sovereign risk throughout the ratings criteria.

    Firstly, it is important to understand the difference between country risk and sovereign risk. The former risk refers to a set of risks of investing a particular country, for example the political, economic, governance, asset price or exchange rate risks. Essentially, these factors are the core parts of our ‘operating environment score’, which is the anchor point of the new GCR ratings methodology. This roots the ratings of an entity firmly within the country or blend of countries it operates in. The country risk criteria is consistently adopted across the GCR ratings universe, even tying to the structured finance ratings to a country risk factor. As a result, any rated entity within the same country, regardless of the sector, will start with the same country risk score. However, companies with wider geographic footprints will have blended country risk scores depending on their breakdown of premium, revenues or loans (depending on the sector). The sector criteria is specific to the underlying asset class.

    Sovereign risk is specifically the risk of a government defaulting on its debt obligations. This factor is also considered for the ‘operating environment score’, as a set of adjustments based on the fiscal, external and geopolitical pressures facing the ‘home’ jurisdiction of any rated entity.

    We believe we capture the risk of sovereign default and other country risk stress by creating hurdles that limit uplift of any legal entity away from its operating environment (the combination of the country risk score and the financial sector risk score). In our opinion, the best bell weather for the accumulation of such risks is the health of the domestic financial system because banks (in particular) can be sensitive to, or indeed the cause of, such risks. For example, the banks are often the largest owners of domestic sovereign debt (ergo very exposed to sovereign default). They also reflect, through their balance sheets, the impact of currency debasement and high/hyper-inflation. Furthermore, the domestic loan books of the banking sector can reveal a lot about economic concentrations and the debt serviceability of the private sector even before stress is evident.

    Ultimately, the criteria have been written so that, with the exception of Supranational Entities, entities need to demonstrate exceptional resilience and diversification to have a GCR risk score well above the country and sector risk score. For more details see the country risk criteria here.

  11. FAQ: How does the concept of country and sovereign risk differ from national to international scale ratings?
  12. Due to the fact that GCR has opted to base the framework on a scoring system, with both international and national scales mapped to the same score, in practice we continue to reflect the risk of country and direct sovereign risk into both the international and national scale ratings. However, through the application of the mapping we believe that we negate sovereign risks from the national scale ratings. This is because the AAA (the theoretical best risk) is mapped to a relatively lower international scale rating.

    Finally, whilst the international scale is fixed to the risk scores, the national scales are determined by the underlying country risk score. As a result, when country risk events happen or a trend is noted, it may change the rating on the international scale. However, the same event may lead to an upwards or downwards revision of the national scale mapping tables, with the intended consequence that we don’t need to change the national scale issue(r) rating relativities because of a sovereign or country risk related event.

  13. FAQ: If GCR do not rate sovereigns how do GCR include sovereign support into the ratings?
  14. Government related and systemically important entities often receive direct support on an ongoing and extraordinary basis. Whilst Central Governments do provide ongoing support to help with the operations of its local authorities, utilities and development organizations (for example), we believe these elements of financial support should be reflected in the ongoing financial profile of the supported entity. However, we have also noted that governments will provide extraordinary support to entities who are experiencing idiosyncratic stress. This ‘extra-ordinary support’ is not reflected on the balance sheet of the supported entity but neither (in our opinion) does it come until there are clear signs of stress. Consequently, we can uplift the ratings on any entity, that is anticipated to receive support, to the operating environment score of its home jurisdiction (combined sector and country risk score) but not above. We use the operating environment score to cap the support to reflect the operational and fiscal restrains of the supporting economy. It also captures the fact that support becomes less dependable during a direct sovereign stress. Importantly, the operating environment doesn’t act a cap the ratings of any underlying entity.

  15. The operating environment appears to be making up the majority of the score, why?
  16. This in fact is not true, although visually it may appear the case for specific ratings. While the operating environment can act as the most significant component of the GCR risk score, especially for issue(r) credit ratings developed markets and sectors, effectively it acts as an anchor point for an issue(r) rating. For example, a bank operating in country ‘x’ may have a blended operating environment risk score of ‘6’. For such a bank we can make negative adjustments, which bring the score down to ‘0’ or up to ‘12’ (due the country risk hurdle cap). If a bank has an operating environment score of ‘20’, we can still bring the score down to ‘0’ or up to 26 (due to the country risk hurdle). This demonstrates our core belief that whilst an entities idiosyncratic factors should not allow an issue(r) to material outperform its operating environment, those factors can cause an entity materially underperform the same environment.

    Furthermore, it is worth noting that, for national scale ratings, the impact of the operating environment score is minimized by the Anchor Credit Evaluator. This is because the ‘b-’ national scale ratings are typically mapped to the ‘country risk’ score of a specific jurisdiction.

  17. FAQ: How are structured finance ratings affected by this new methodology?
  18. Whilst structured finance ratings are not directly in scope of the new framework, it may have an impact on the way we view counterparty ratings included in those assessments. Furthermore, the country risk assessment will directly lead to the country risk factor scoring used by the structured finance team to come up with their stresses. See the structured finance criteria for more information. Importantly, we expect minimal changes from these small changes in the short-term.