What is the WARF, or weighted average rating factor?
Credit rating agencies use the weighted average rating factor (WARF) to assess a portfolio’s credit quality. This metric creates a single rating by combining the credit ratings of all the assets in the portfolio. Most of the time, WARFs are computed for collateralized debt obligations (CDOs).
The Weighted Average Rating Factor (WARF): An Understanding
The rating agencies must first assign a credit rating to each underlying instrument in a CDO before they can compute the weighted average rating factor on the CDO. For instance, this rating might vary from very high credit quality (AAA) to poor quality (CCC) to default (D) in the Fitch Ratings taxonomy. The 10-year chance of default is correlated with a numerical rating component derived from this letter rating. The weighted average of these numerical elements is what determines the WARF. To calculate the weighted average, multiply the notional balance of the asset by the rating factor. Next, divide this amount by the portfolio’s entire notional balance.
