Can accounting-based and market-based indicators predict changes in the risk rating of brazilian banks?
| Autor | Garcia, Ronaldo Trapia |
1 Introduction
Ratings are an analysis tool of the financial market that allow companies and investors to qualify countries, economic areas, and companies, and to measure investment risks (Shen, Huang, & Hasan, 2012; Distinguin, Hasan, & Tarazi, 2013; Ioana, 2014). It is difficult for a big company or country to secure credit with investors before being assessed by a risk rating agency regarding its capacity to comply with its commitments (Adams, Burton, & Hardwick, 2003; Papaioannou, 2011). Specifically for the financial market, ratings are very important for banks because, according to Murcia, Dal-Ri Murcia, Rover, and Borba (2014), the cost of debt of new loans and financing is more expensive when their risk ratings are downgraded.
Several studies recommend the auxiliary use of market indicators to predict an upgrading or downgrading in the rating of a bank (Berger, Davies, & Flannery, 2000; Curry, Fissel, & Hanweck, 2008). In general, these studies show that market data such as stock returns substantially improve the predictive ability of models based entirely on accounting data (Krainer & Lopez, 2004; Adelino & Ferreira, 2016; Moody's, 2016). According to the literature, risk rating agencies state that other market indicators such as sovereign risk also tend to influence banks, especially regarding fundraising sources and stock and security prices (Acharya, Drecshler, & Schnabl, 2014; Adelino & Ferreira, 2016; Moody's, 2016).
However, in emergent markets, most of the studies on predicting bankruptcy mainly focus on crisis alerts regarding the whole financial system, in particular after the financial crisis of 1997 (Demirguc-Kunt & Detragiache, 2000; Distinguin, Hasan, & Tarazi, 2013; Sanfins & Monte-Mor, 2014). In other words, such studies focus on analyzing systemic crises and not on the financial health of individual banks, especially within the scope of the regulatory framework implemented by the Basel Committee on Banking Supervision and the Basel III Agreement (Distinguin, Hasan, & Tarazi, 2013).
In Brazil, specifically, there are no models that relate market-based and accounting-based indicators to changes in the risk ratings of banks. There are only studies about predicting bankruptcy based on analyses that use the Z-Score model developed by Altman (1968), which was created to measure insolvency risks but only takes into consideration accounting-based indicators that do not contain probability aspects and uses random criteria when gathering normal variables (Murcia et al., 2014).
This paper aims to analyze if market-based indicators, as a complement to accounting-based indicators, can anticipate changes in the risk ratings ofbanks in Brazil. The discussion should contribute empirically to the literature regarding ratings changes in banks within countries with volatile financial markets subject to political and economical uncertainties and regular changes to their sovereign risk ratings, such as the Brazilian market.
Between 2006 and 2016, Brazil achieved investment grade, considerably affecting foreign direct investment, but lately its credit grade has been continuously downgraded back to a speculative grade rating (Standard & Poor's, 2016). Also, the country has faced an economic crisis linked to political and financial instability, as well as company failures, including banks. Such movements can change the ratings dynamics of financial institutions (Adelino & Ferreira, 2016).
The specifics of the Brazilian financial market also warrant empirical research, since it has different characteristics from the developed countries where similar studies have been carried out. For example, Brazil has a smaller stock market, companies with concentrated control, big banks directly controlled by the federal government, and rigid regulation (Murcia et al., 2014).
According to the results found by Distinguin, Hasan, and Tarazi, (2013), who state that for Asian banks accounting-based indicators together with indicators resulting from market price can affect the probability of upgrades and downgrades being issued by risk rating agencies, market-data indicators together with accounting-based indicators are expected to predict changes issued by the credit rating agencies (CRAs) to the banks in Brazil.
To enable the analysis of whether marketbased indicators, together with accounting-based indicators, can anticipate changes in the ratings of banks in Brazil, the probit model was applied to 13 banks listed on the BM&F Bovespa from 2010 to 2014. This study follows other studies: Curry, Fissel, and Hanweck (2008), who tried to find downgradings in USA banks; Gropp, Vesala, and Vulpes (2006), who tried to predict bankruptcy in European banks; and the study by Distinguin, Hasan, and Tarazi, (2013), who predicted ratings changes for Asian banks.
In this study, the accounting-based indicators were divided into four (4) groups: Asset Quality; Liquidity; Capital and Profitability; and Risk, as in the methodology used by the rating agencies Moody's (2016), Fitch (2015), and Standard and Poor's (2011). The market-based indicators were the banks' market prices (Distinguin, Hasan, & Tarazi, 2013), GDP growth (Gande & Parsley, 2014; Acharya, Drecshler, & Schnabl, 2014), and sovereign ratings changes (Adelino & Ferreira, 2016).
This study assesses the use of market-based indicators such as sovereign risk, market return, and economic-systemic factors as signals of risk in volatile and insecure markets. The study is important for three groups: for investors, according to Papaioannou (2011), the research anticipates information that helps in the decision to purchase, keep, or sell bonds; for banks, it is important to present information that can justify increasing or decreasing the interest rate of creditors (Gullo, 2014); and, finally, for creditors, it is important because it can predict changes to companies' credit risks (Ioana, 2014). Besides influencing investment, ratings changes can affect the future value of stocks and the cost of fundraising (Li et al., 2008), as well as debt structure and market value (Murcia et al., 2014).
Especially for the financial market, ratings are very important to banks because, according to Murcia et al. (2014), the cost of new loans and financing is more expensive when their risk ratings are downgraded. In the last version of the Basel agreement, Basel III, the world's concern about the possibility of bank insolvency is clear, because the focus of the changes is divided into three points: leverage limits, required liquidity percentages, and discussions about pro-cyclicity (Braslins & Arefjevs, 2013). Since Brazil already has rigid regulations regarding banks and adopts the Basel III recommendations, there is great interest in checking the main factors that determine ratings (Pinheiro, Savoia, & Securato, 2015).
2 theoretical References
2.1 Ratings and the Credit Rating Agencies (CRAs)
The risk rating system is a process that involves analyzing the financial strength and risk exposure of companies/countries (Moody's, 2016; Fitch, 2015; Standard & Poor's, 2011). In 2015, the three biggest international rating companies were Fitch, Moody's, and Standard & Poor's (Distinguin, Hasan, & Tarazi, 2013). According to Gaillard (2014), to develop ratings, the agencies (CRAs) visit the companies and countries assessed in order to discuss financial and operational plans and performance strategies among all participants.
To rank a country as investment grade, at least two of these three companies need to consider it a good payer; otherwise the country is ranked in the speculation group (Gaillard, 2014). According to Murcia et al. (2014), it is hard for a company to be granted investors' credit without being assessed by one of these rating companies regarding its ability to pay debts. The authors also emphasize that the interest rates charged for loans and financing are directly connected to this rating.
Picture 1 shows the risk ratings used by each one of the three agencies. We can notice that, despite some differences regarding names, the pattern of risk assessment is similar. The scales are divided into four blocks of risk. The higher level is investment grade with high quality and low risk. The countries and companies within the first and second level groups are considered good payers and have a lower possibility of failure (Ioana, 2014). In the third group, the companies and nations are rated as speculation level and are considered bad payers. In this group, there is a risk of failure so the fees paid to investors are high (Hill, 2004). These ratings are important for the Basel III Agreement and our next section describes the implementation of the agreement in Brazil.
2.2 Accounting and market indicators
According to Standard & Poor's (2009), to determine ratings, the possibility of default is the most relevant dimension in credit quality and in the definitions of risk rating we assign a high importance to probability of default.
Besides probability of default, some secondary items of credit quality are taken into consideration: payment priority, credit recovery, and stability; and these can become important elements when applying the ratings definitions to the development of criteria for the specific situations of banks (Standard & Poor's, 2009). The main accounting ratio used to analyze financial institutions is divided into four groups: Asset Quality; Liquidity; Capital and Profitability; and Risk (Moody's, 2016; Fitch, 2015; Standard & Poor's, 2011).
The first group, Asset Quality, has some impact on the rating because, according to Fitch's methodology (2015), most bank assets are calculated as amortized cost minus allowance for losses so assets with low performance can negatively affect bank capital. Thus, it is considered that high concentrations, geographically speaking, by product or customer segment, expose banks to risks and will probably be negative factors for ratings...
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