Determinants of Credit Ratings of Structured Finance Products in the United States

Abstract

Credit Rating is an appraisal of the credit worthiness of an individual, business, government or financial product. This appraisal is done by Credit Rating Agencies based on capability of account holder to repay the borrowings or honor the financial commitments stipulated within the established time frame. Credit Ratings have a crucial part in the financial markets of helping bridge the informational gap between investors and borrowers on the security and reliability of the assets being traded. This informational gap is larger in the market for structured finance products due to increased complexity of the structured finance products; therefore credit ratings have an even more important part in this market. Developing a grasp of the elements/variables that determine credit rating is therefore crucial in the structured finance products market because there is a huge reliance of investors on CRAs providing some assurance on the safety of the products. This research sought to identify and assess the determinants of structured finance products credit ratings in the United States (US). The predictor variables were maturity, default probabilities and recovery rates of the underlying assets and seniority and the response variable was credit rating. The population of the study was the new issuances of US Consumer Asset Backed Securities in 2019. Data was collected from the Fitch Ratings website and the Financial Industry Regulation Authority (FINRA) website. A sample of 152 issues was determined by use of stratified sampling. Multiple linear regression was performed to ascertain the connection between the variables and a descriptive research design was utilized. The data analysis utilized SPSS version 28.. An R square score of 0.711 was obtained which was translated to mean 71.1% of the variations in credit rating for US Consumer ABS can be explained by the 4 chosen predictor variables. 28.9% of the variation in credit rating was said to be explained by other variables/factors that were not part of this research. Further analysis showed that maturity and default probabilities had a negative correlation with credit rating while recovery rates and seniority had a positive correlation with credit rating. Additionally, results showed that maturity and seniority had a statistically significant influence on credit rating while recovery rates and default probabilities were not statistically significant predictors of credit rating. The study concluded that maturity of underlying assets and seniority were the most significant factors influencing credit rating. Seniority was shown to have the strongest influence on credit rating and therefore the priority of distribution of payments to investors of structured finance products was concluded to be one of the most significant determinants of credit quality. The study recommended that Credit Rating Agencies should also examine the relevant characteristics of the underlying assets of the structured finance products as these characteristics have been shown to influence credit rating of structured finance instruments. The study recommended the need for further research on other variables such as level of collateralization, level of excess spread, performance of collateral managers and macroeconomic variables such as inflation and interest rates and their influence on credit ratings of structured finance products.