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ARC: WHAT COMPANIES NEED TO KNOW TO PROTECT THEMSELVES FROM REPUTATION RISKS

Reputation risk in focus at credit rating agencies

Photo by AP PHOTO Moody's placed Penn State University's rating on review for a possible downgrade as it weighed potential reputational damage from allegations.

High-profile events, such as child sexual abuse allegations involving Pennsylvania State University and the Costa Concordia cruise ship capsizing off the coast of Italy, have focused credit rating agencies' attention on reputational risks.

A damaged reputation can significantly affect an organization's bottom line and, ultimately, its ability to borrow capital.

Doug Kilcommons, managing director and sector head for the education and nonprofit institutions group for Fitch Ratings Ltd. in New York, said the rating agency's primary focus is the ability and willingness of an entity to make full and timely payment of debt service on its financial obligations.

“To the extent that a poor reputation prevents that ability, we would be very concerned,” he said.

More than a decade ago, Standard & Poor's Corp. “significantly increased” its emphasis on reputational risks related to corporate governance, said Mark Puccia, chief criteria officer of global corporate ratings at S&P in New York.

“We are highlighting the governance-related elements of this much more these days,” Mr. Puccia said. “So to the extent that we identify governance-related concerns that could cause reputational risk, absolutely that is a ratings consideration. And it does change ratings.”

As reputational risks emerge for a company or organization, S&P estimates the impact on revenue and cash flow and how that changes debt servicing needs, he said.

Two days after the Carnival Corp. cruise ship ran aground and capsized, S&P issued a bulletin saying that costs associated with the Costa Concordia disaster would negatively affect Carnival's 2012 operating performance, including “any investment associated with restoring the reputation of the Costa brand, which is one of Carnival's largest and most well-known.”

“That's an example where reputational risks emerged, we identified it and immediately started to make some projections about that,” Mr. Puccia said.

In the Penn State case, Moody's Investors Services Inc. placed the university's rating on review for possible downgrade in November as it weighed potential reputational damage days after misconduct allegations surfaced involving former assistant football coach Gerald A. Sandusky and two former senior university officials.

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This month, Moody's confirmed Penn State's long-term credit rating of Aa1 with a negative outlook, citing indirect effects on enrollment and philanthropy as reasons for the negative outlook.

Public universities rely heavily on their reputation and brand as a strategic asset to attract students, philanthropic support and research grants, said John Nelson, managing director for university and hospital ratings at Moody's in New York.

In addition, there has been “more of an emphasis” on reputational risks for universities as support from financially strapped state governments has dwindled, Mr. Nelson said.

“So, across the board, universities are heavily reputation-driven and we measure that in a variety of indicators,” which include its selectivity in accepting students and growth in donations and research funding, he said.

“Those are pretty important strategic drivers in the university world and pretty important credit factors when evaluating the risk of them retaining their debt,” Mr. Nelson said.

Randy Nornes, executive vp of Aon Risk Solutions in Chicago, said reputational distress within an organization increases uncertainty, prompting rating agencies to issue warnings or actions more quickly.

“Companies go on and off watch lists all the time. It's a red flag. Most manage through it,” Mr. Nornes said. “But when the red flag turns into more sustained liquidity issues...it might trigger a material adverse change clause in a loan facility,” which would require immediate payment or adjustment of interest rates or change other terms of the loan.

“From a treasury standpoint, that's a big deal because (the organization is) charged with managing liquidity,” he said.

Organizations are aware how reputational risks can affect their credit rating, and experts say proactive organizations attempt to work directly with these issues as they arise (see box).

“Increasingly we've also seen universities really develop enterprise risk management systems, and part of that is to cover this type of reputational issue that may come up over time,” he said.

Howard Mills, director and chief adviser in the insurance industry group at Deloitte L.L.P. in New York, said much of the awareness is driven by today's 24-hour news cycle and social media's potent ability to disseminate bad news quickly.

“Clearly, you're seeing the credit rating agencies responding to this heightened awareness,” Mr. Mills said. “Institutions are obviously very concerned with their rating as well as their reputation; and now, the two are irrevocably linked, it seems.”

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