What Is Weighted Average Rating Factor (WARF)
Let me explain what the weighted average rating factor, or WARF, really is. It's a tool that credit rating companies use to show the overall credit quality of a portfolio. You see, it takes all the credit ratings from the holdings in that portfolio and boils them down into one single rating. I find that WARFs are usually calculated for things like collateralized debt obligations, which we call CDOs.
Understanding the Weighted Average Rating Factor (WARF)
To get the WARF for a CDO, rating agencies start by figuring out a credit rating for every instrument that's backing it. Take Fitch Ratings as an example—their ratings go from top-notch credit quality like AAA down to low quality like CCC, and even to default, which is D. Each of these letter ratings ties to a numerical rating factor, and that factor relates to the 10-year probability of default.
Here's how you determine the WARF: you calculate the weighted average of those numerical factors. Multiply the notional balance of each asset by its rating factor, add all those up, and then divide the total by the overall notional balance of the portfolio. That's it—straightforward and direct.
