Rosemarie Conforte David Fanger Sean Jones Michael Mascarenhas Les Muranyi Alan Reid Allen Tischler Carmen Y. Manoyan Gregory W. Bauer
Ratios And US Bank Ratings: Our Old “Favorites” And Some New Ones
Ratio analysis remains essential to our ratings process, even though some ratios tend to belagging indicators of potential credit losses. It is thus not surprising that investors and issuers have frequently asked Moody’s what ratios are used in establishing our bank ratings.1
…what’s new in this report?…
We have traditionally highlighted statistical analysis based on ratios that are derived from publicly available data. However, this report highlights other quantitative issues thatare critical to our analysis but cannot be calculated from public information on a comparable basis. The ratios we highlight center around concentration risk, such as loan concentrations by industry, single and family relationship loan exposures, and earnings concentration in certain lines of business. Banks often share such information with us, but this information can be less consistent than thatcontained in regulatory reporting. This lack of consistency makes it more difficult for Moody’s to compare peer institutions. However, such information is essential in the ratings process because it allows us to better understand the potential risks to the franchise and thus, the implications for the company’s ability to provide creditor protection.
…qualitative factors remain as significant asever…
We continue to emphasize qualitative factors in addition to quantitative analysis, given their key role in determining ratings. Core earnings, asset quality and liquidity are key areas of focus in assessing depositor and bondholder protection, but subjective factors, such as management quality, risk appetite, and strategies, are also crucial in this assessment. Franchise value, a keyrating driver, is both a quantitative and qualitative measure, and often we focus on both aspects. Moody’s has also begun a program of expanded analysis of qualitative issues, with particular emphasis on corporate governance, financial reporting, and risk management.
1. In 1998, we started publishing rating methodologies highlighting our “favorite” ratios. Our “favorite” ratios have expanded overtime; our December 2002 methodology focused on 12 key ratios. Today, our “old” favorites — outlined in the 2002 report — are still relevant.
Additional “Favorite” Ratios — And Their Limitations
...focused on concentration risk...
In this report, we highlight several additional ratios that we find important to our analysis, all revolving around concentration risk. Moody’s views concentration riskas a negative rating factor because undue exposure to a volatile sector or borrower could translate into significant losses. We generally measure concentration as a percentage of core earnings (pre-provision, pre-tax earnings) because this is consistent with our view that core earnings represent the first and most important line of defense for creditors’ interests. We also are interested inrelating concentrations to tangible capital (TCE), which represents the second level of bondholder protection; in the case of problem credits, we add loan loss reserves to TCE. Consequently, we view healthy capital levels as being positive in terms of bondholder and depositor protection.
…what these ratios tell us…
As we have noted, some ratios are calculated from data that may not be publiclyavailable or may not be consistently available in public financial statements, which limits comparability across issuers. Nevertheless, for an individual institution, measuring risk concentration against core earnings allows us to gauge the company’s ability to earn its way out of the potential losses that could stem from deterioration or severe weakness in any of its risk assets. The ratios also...