A Brief History Of Credit Rating Agencies

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A Brief History Of Credit Rating Agencies

Investors, both retail and institutional, may benefit from credit ratings since they provide information that can assist them in determining whether or not issuers of bonds and other debt instruments and fixed-income securities will be able to fulfill their promises.

When it comes to assigning letter grades, credit rating agencies (CRAs) provide organizations and governments who are in the business of issuing such instruments with objective research as well as independent evaluations. The following is a brief history of the evolution of ratings and agencies in the United States, as well as their expansion to benefit investors in other parts of the globe.

Key Takeaways

  • Investors have access to a variety of studies and analyses conducted by credit rating organizations, which provides them with knowledge and insight that assists them in researching and comprehending the risks and opportunities connected with a variety of investment scenarios. With this information, investors will be able to make more informed decisions on the countries, industries, and assets in which to invest.
  • Investors have access to a variety of studies and analyses conducted by credit rating organizations, which provides them with knowledge and insight that assists them in researching and comprehending the risks and opportunities connected with a variety of investment scenarios. With this information, investors will be able to make more informed decisions on the countries, industries, and assets in which to invest.
  • Investors have access to a variety of studies and analyses conducted by credit rating organizations, which provides them with knowledge and insight that assists them in researching and comprehending the risks and opportunities connected with a variety of investment scenarios. With this information, investors will be able to make more informed decisions on the countries, industries, and assets in which to invest.
  • Investors have access to a variety of studies and analyses conducted by credit rating organizations, which provides them with knowledge and insight that assists them in researching and comprehending the risks and opportunities connected with a variety of investment scenarios. With this information, investors will be able to make more informed decisions on the countries, industries, and assets in which to invest.
  • Investors have access to a variety of studies and analyses conducted by credit rating organizations, which provides them with knowledge and insight that assists them in researching and comprehending the risks and opportunities connected with a variety of investment scenarios. With this information, investors will be able to make more informed decisions on the countries, industries, and assets in which to invest.

An Overview of Credit Ratings

Countries may be given different ratings for their sovereign debt. This score is an evaluation of the overall creditworthiness of a nation or government of another country. The overall economic conditions of a nation are included into sovereign credit ratings. These conditions include the quantity of international, public, and private investment, the transparency of the capital market, and the amount of foreign currency reserves. Ratings of sovereign nations take into consideration a variety of political factors, including the degree to which a country will be able to maintain its economic stability even if its government undergoes significant shifts in power. When evaluating and assessing a country’s overall investment environment, institutional investors rely on sovereign ratings as their primary source of information. Institutional investors often consult the sovereign rating in order to determine whether or not they will investigate certain companies, industries, and types of securities that are issued in a particular country.

Credit ratings, debt ratings, and bond ratings may be assigned to specific companies as well as specified categories of individual assets. Examples of these categories include preferred stock, corporate bonds, and various categories of government bonds. Independent evaluations may be carried out for both short-term and long-term obligations simultaneously. Ratings on the long term investigate and assess a company’s ability to fulfill its commitments in relation to all of the securities it has issued. The focus of short-term ratings is on the ability of individual securities to perform well in light of the current financial situation of the firm and the larger performance circumstances of the industry as a whole.

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The Big Three Agencies

Moody’s, Standard & Poor’s, and Fitch are the three agencies that control almost all of the world’s credit rating industry, making it one of the most concentrated industries in the world. 1 2 The cooperation between borrowers and lenders is beneficial for all parties involved, including the lenders. They seek to deliver information that is reputable and truthful to the market on the dangers that are involved with the many different kinds of debt.

Fitch Ratings

The credit rating agency Fitch is consistently ranked among the top three in the world. It operates in New York and London, rating businesses according to the amount of debt they carry and the degree to which they are susceptible to changes in factors such as interest rates. When it comes to matters pertaining to sovereign debt, governments seek rating organizations like Fitch and others to evaluate not just their current financial situation but also the political and economic climates in which they operate.

Investment grade ratings from Fitch vary from AAA all the way down to BBB. These letter grades signify that there is a very low to completely non-existent chance of default on the loan. Ratings that are not considered investment grade vary from BB to D, with D being the lowest and signifying that the debtor has already failed. 3

History

John Knowles Fitch started the Fitch Publishing Company in 1913. The company was responsible for publishing “The Fitch Stock and Bond Manual” and “The Fitch Bond Book,” which were both sources of financial information for the investing industry. 4 In 1923, Fitch developed the rating scale that consists of AAA through D, and it has since remained the norm for the business. 5 In the late 1990s, Fitch merged with IBCA of London, which was a subsidiary of Fimalac, a French holding company, with the objective of creating a full-service rating agency that could operate anywhere in the globe. Along with Thomson BankWatch and Duff & Phelps Credit Ratings, Fitch acquired both of these companies. 6 Beginning in 2005, Fitch began to build operational subsidiaries that specialized in enterprise risk management, data services, and finance industry training. This was accomplished through the acquisition of a Canadian company known as Algorithmics, as well as the formation of Fitch Solutions and Fitch Training (now Fitch Learning).5

Moody’s Investors Service

A rather unique approach is used by Moody’s when assigning letter ratings to the debt of countries and corporations. The lowest possible rating for investment grade debt is a baa3, which indicates that the debtor is able to repay short-term debt. The highest possible grade for investment grade debt is aaa. A speculative grade of debt, often known as high-yield or garbage debt, is a grade of debt that is lower than investment grade. These grades go from Ba1 all the way up to C, and the chance of repayment reduces as one moves down the alphabetic scale. 7

History

The first edition of “Moody’s Manual” was published by John Moody & Company in the year 1900. The handbook included fundamental data and general information about the stocks and bonds of a variety of different businesses. Between the years 1903 and 1907, when the stock market crashed, “Moody’s Manual” was a nationally distributed publication. In the year 1909, Moody’s began publishing a report called “Moody’s Analyses of Railroad Investments,” which included informational analyses pertaining to the value of various assets. Expanding on this idea led to the founding of Moody’s Investors Service in 1914. Over the course of the next decade, Moody’s Investors Service would provide ratings for almost all of the government bond markets that existed at that time. In the 1970s, Moody’s began doing ratings on commercial paper and bank deposits; this was the first step on the company’s path to becoming the full-service rating business it is today. 8

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Standard & Poor’s

The total number of ratings that S&P assigns to business and government debt is 17. The term “investment grade” refers to anything having a rating between AAA to BBB-, which indicates that it can make debt payments without any problems. Debt that has ratings ranging from BB+ all the way down to D is regarded to be speculative since its future is uncertain. The higher the letter grade, the less likely it is that the obligation will be met, with a D grading being the worst possible outcome. 9

History

In 1860, Henry Poor Varnum produced “History of Railroads and Canals in the United States,” which was a precursor to the growth of securities research and reporting over the course of the next century. 1906 was the year that Standard Statistics first started releasing ratings for corporate bonds, government debt, and municipal bonds. Standard Statistics and Poor’s Publishing merged to become the Standard and Poor’s Corporation in 1941. In 1966, The McGraw-Hill Companies acquired the company and renamed it Standard and Poor’s. Standard and Poor’s is the most well-known rating agency because of market indices such as the S&P 500, which is a stock market index that functions as a tool for investor research and decision-making as well as an economic indicator for the United States.8

Nationally Recognized Statistical Rating Organizations

1970 was the year that saw the beginning of the credit rating industry’s implementation of several key changes and breakthroughs. Investors were required to pay subscription fees in order to gain access to each of the rating agencies’ publications; however, issuers were not required to pay any fees in order to take part in the research and analysis that was typically involved in the process of establishing published credit ratings. Credit rating companies came to realize as a business necessity that issuers received significant benefits from objective credit ratings. These benefits included increased access to capital, which was accomplished by increasing a securities issuer’s market value, and decreased costs associated with obtaining capital. As a consequence of the development and increased complexity of the capital markets, as well as the rise in demand for statistical and analytical services, the decision was taken to charge issuers of securities fees for ratings services. These fees will cover the costs of providing the ratings. 10

In 1975, commercial banks and securities brokers were among the financial institutions that advocated for a relaxation of the capital and liquidity restrictions imposed by the Securities and Exchange Commission (SEC) (SEC).As a direct result of this, nationally recognized statistical rating organizations, abbreviated NRSROs, came into existence. Investing in securities that have been given a favorable rating by one or more of the NRSROs is one way for financial institutions to satisfy their capital requirements. This clause is the result of greater SEC supervision and control of the credit ratings industry, as well as the registration requirements that have been imposed on the industry. A increasing demand for ratings services from investors and securities issuers, as well as greater regulatory oversight, has contributed to the growth and expansion of the credit rating sector. 11

Regulation and Legislation

As a result of the worldwide nature of the operations of the main CRAs, regulation occurs on several levels. Congress voted in favor of the Credit Rating Agency Reform Act of 2006, which gave the SEC the authority to monitor the internal processes, record-keeping, and some commercial operations of CRAs. Dodd-Frank Act The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 mandated the disclosure of credit rating methodology, which resulted in an expansion of the regulatory jurisdiction of the Securities and Exchange Commission (SEC). 12

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There are many governing bodies that oversee credit rating organizations.

The European Union (EU) has never created a single entity in charge of CRA regulation, nor has it ever implemented legislation that are clear or systematic in nature. Rating agencies, their business practices, and the criteria for their level of openness are all affected by a number of pieces of EU law, one of which is the Capital Obligations Directive of 2006. 13 The European Securities and Markets Authority is in charge of the majority of the directives and regulations that have been established. 14

The Financial Crisis

After the financial crisis and the Great Recession that occurred from 2007 to 2009, credit rating firms came under a great deal of regulatory pressure and rigorous scrutiny. It was believed that CRAs provided excessively positive ratings, which led to unprofitable investments. Mortgage-backed securities continued to get AAA ratings from the rating agencies despite the risk they posed, which was a part of the problem (MBSs).Many potential investors were led to believe that these assets posed very little to no risk at all, despite the widespread perception to the contrary. The rating agencies were accused of aiming to enhance their revenues and market share in exchange for these inaccurate ratings, which led to the accusations. This played a part in the collapse of the subprime mortgage business, which in turn precipitated the global financial crisis.

In order to add gasoline to the fire, the ratings of European national debt that were given by the agencies were investigated. The ratings of other EU members have been lowered as a direct result of the destruction created by the financial problems that have affected a number of European nations, most notably Greece and Portugal. 15

Some people feel that authorities have helped to keep the credit rating industry an oligopoly by passing regulations that make it difficult for smaller or medium-sized agencies to enter the market. These laws function as barriers to entry. 16 CRAs have been held liable for inaccurate or careless ratings that cause an investor damage as a result of new guidelines implemented in the EU. 17

The Bottom Line

Information from a single rating agency or information from many agencies may be used by investors. It is required of credit rating organizations to provide objective information that is based on sound analytical procedures and trustworthy statistical evaluations. In the same way that credit rating agencies adhere to the reporting procedures set by securities industry regulating bodies, investors anticipate that issuers of securities will comply with the rules and regulations that have been created by governing organizations.

Investors have access to a variety of studies and analyses conducted by credit rating organizations, which provides them with knowledge and insight that assists them in researching and comprehending the risks and opportunities connected with a variety of investment scenarios. With this information, investors will be able to make more informed decisions on the countries, industries, and assets in which to invest.

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