Bond rating agencies and credit bureaus are similar in that they both do financial research to establish creditworthiness. A bond rating agency, on the other hand, analyzes whether issuers of debt products such as bonds are likely to meet their obligations to pay interest and repay the principal you gave them, rather than appraising an individual’s likelihood of repaying their debts.
Rating agencies assist bond investors in determining where to put their money and whether the risk of purchasing a debt instrument is worth the promised interest rate. In general, greater-risk bonds must give higher interest rates to investors in order to appear desirable.
Fitch Ratings, Standard & Poor’s Global Ratings (S&P Global Ratings), and Moody’s Investors Service are the three largest bond rating firms in the United States, accounting for approximately 95 percent of all bond ratings. Because each agency has its own review technique, they may provide different scores to the same security.
The Securities and Exchange Commission (SEC) designated these three agencies as nationally recognized statistical rating organizations in 1975, despite the fact that they are private firms (NRSROs). Although the SEC has added more NRSROs since then, Fitch, S&P, and Moody’s continue to dominate this market.
Why should a rating agency rate a bond?
The bond grading procedure is crucial since it informs investors about the bond’s quality and stability. That is to say, the credit rating has a significant impact on interest rates, investment appetite, and bond price. Furthermore, ratings are assigned by independent rating agencies based on future expectations and prognosis.
U.S. Securities and Exchange Commission
Standard & Poor’s Ratings Services (“Standard & Poor’s”), a division of The McGraw-Hill Companies, Inc. (“McGraw-Hill”), is pleased to participate in the Securities and Exchange Commission’s public hearings on the role and function of credit rating agencies in the United States securities markets, as well as to share its views on important policy issues to be addressed in the Commission Study and Report Regarding Credit Rating Agencies mandated by the Sarbanes-Oxley
Standard & Poor’s has rated hundreds of thousands of securities offerings, corporate and governmental issuers, and complex financings since 1916, when it began its credit rating activities.
Standard & Poor’s began its operations by assigning credit ratings to corporate and government obligations.
Standard & Poor’s assesses the credit quality of, and assigns credit ratings to, financial guarantees, bank loans, private placements, mortgage- and asset-backed securities, mutual funds, and the ability of insurance companies to pay claims, as well as assigning market risk ratings to managed funds in response to market developments and needs.
Standard & Poor’s currently has credit ratings on about 150,000 obligor-issued securities in more than 50 countries.
Standard & Poor’s ratings and monitors these securities and obligors from operations in 21 worldwide cities across 16 countries.
Standard & Poor’s rates more than 99.2 percent of the debt obligations and preferred stock issuance publicly traded in the United States, with a staff of around 1,250.
Credit ratings, according to Standard & Poor’s, have served the US securities markets exceptionally well throughout the previous century as an effective and objective tool for the market to evaluate and assess credit risk.
Standard & Poor’s supports a more open and transparent process for designating Nationally Recognized Statistical Rating Organizations (“NRSROs”), and believes that the designating criteria should emphasize market recognition as well as a credit rating agency’s independence, objectivity, and transparency in its rating process.
Standard & Poor’s recognizes the unique and valuable role that credit rating agencies play in the U.S. securities markets, and it is committed to safeguarding its credit ratings business’s reputation and future by ensuring that integrity, independence, objectivity, transparency, credibility, and quality remain fundamental operating principles.
The remainder of this paper replies to the Commission’s specific concerns while keeping these fundamental principles in mind.
Role and Function of Credit Rating Agencies
Credit ratings are an important part of the capital markets and have been in use in the United States for than a century. With the expansion of global financial markets, the role of credit ratings is expanding and prospering in many countries throughout the world. Credit ratings assist the market in evaluating and assessing credit risk, pricing debt instruments, benchmarking issues, and establishing a dynamic secondary market for such issues.
Meeting the highest criteria of honesty, independence, objectivity, transparency, trustworthiness, and quality is critical to a credit rating agency’s ability to play this critical market role.
Because of Standard & Poor’s good track record and reputation, credit ratings have gained worldwide investor approval and recognition as widely used tools for differentiating credit quality.
Regardless of the changing climate, Standard & Poor’s essential values remain unchanged: to supply the marketplace with high-quality, objective, value-added analytical information.
It’s crucial to grasp what a credit rating is in order to comprehend the role of credit rating agencies in the financial markets.
A Standard & Poor’s credit rating reflects Standard & Poor’s assessment of an obligor’s creditworthiness in general or with respect to a specific financial obligation as of a certain date.
Standard & Poor’s credit ratings for issuers and issues can be long-term or short-term, indicating Standard & Poor’s evaluation of a company’s ability to satisfy its financial obligations over a long-term or short-term time horizon.
Credit ratings are issued by Standard & Poor’s in the form of symbols that are generally recognized and understood in the market.
A credit rating is not investment advice or a suggestion, and it has nothing to do with the market price of securities or the suitability of an investment for specific investors.
Credit ratings are fundamentally distinct from analyst recommendations on whether to buy, sell, or hold an asset issued by equities or fixed-income experts.
Standard & Poor’s credit ratings are based mostly on publicly available information about an issuer, as well as extra information provided by the issuer, as well as other economic, financial, and industry data deemed relevant and reliable by rating analysts.
Standard & Poor’s credit ratings are unavoidably based on projections of future performance.
Standard & Poor’s, on the other hand, examines its analyses on a regular basis since unforeseen or simply unknowable situations occur.
A credit rating is subject to continual monitoring, or surveillance, after it has been assigned, and it can be altered at any time depending on newly available information.
Changes in the completeness, availability, or dependability of information can also cause credit ratings to be suspended or revoked.
Standard & Poor’s does not audit or grade the work of the company’s auditors, nor does it repeat the auditors’ accounting evaluation.
Standard & Poor’s relies on the integrity and quality of the company’s publicly available financial reports and financial statements, and it expressly relies on the rated company to provide current and timely information – both at the time of the initial rating and on an ongoing basis for proper creditworthiness surveillance.
If an issuer refuses to give requested information, Standard & Poor’s may issue a lesser rating, refuse to provide a rating, or even revoke an existing rating, depending on the significance of the material requested.
The whole credit rating business of Standard & Poor’s is predicated on the full and fair disclosure system established by federal securities laws in the United States.
The agreement between the company seeking the rating and Standard & Poor’s itself, as set forth in Standard & Poor’s detailed reports on rating criteria and methodologies and other publications, is at the heart of the process that leads to a credit rating being issued by Standard & Poor’s: the company is required to provide Standard & Poor’s with complete, timely, and reliable information on an ongoing basis.
The events of the last year have clearly illustrated the ramifications for all market participants, including credit rating agencies, when corporations fail to meet their disclosure responsibilities, or worse, set out to deceive investors or rating agencies.
The Commission’s efforts over the previous year to improve the quality, transparency, and timeliness of public business disclosures should help Standard & Poor’s evaluate a company’s creditworthiness significantly.
Similarly, measures to improve the openness of financial accounts through accounting standards should benefit creditworthiness analysis.
Not just with issuers and investors, but also with bankers, financial intermediaries, and securities dealers, market acceptability and acknowledgment of a credit rating is based on the credibility of the credit rating agency issuing the credit rating.
The market’s acknowledgement of Standard & Poor’s credit ratings and rating methodology’ independence and objectivity, as well as its strong track record, underpins the credibility of Standard & Poor’s credit ratings.
Standard & Poor’s regularly publishes its ratings definitions, detailed reports on rating criteria and methodology, and default studies demonstrating its track record, all of which are freely available to the public, in hard copy and on Standard & Poor’s website, because it is critical that all users of Standard & Poor’s credit ratings understand how Standard & Poor’s analyzes creditworthiness.
Standard & Poor’s uses an uniform credit rating procedure across different types of ratings and markets, including the use of rating committees in conjunction with original ratings and rating actions, as well as surveillance to monitor a company’s ongoing creditworthiness.
Studies on rating trends have frequently established that there is a definite association between initial ratings assigned by Standard & Poor’s and the chance of default: the higher the original rating, the lower the possibility of default, and vice versa.
The table below displays the cumulative default history of issuers rated by Standard & Poor’s during the last 15 years, based on the rating category they were assigned at the time.
This clearly indicates the very low risk of default for an issue rated in the “AAA” category (just 0.52 percent have defaulted in the last 15 years), compared to the substantially higher risk of default for an issuer rated in the “CCC” category by Standard & Poor’s (54.38 percent have defaulted in the past 15 years).
Information Flow in the Credit Rating Process
Information sources. Standard & Poor’s rating analysis is based primarily on public information provided by the issuer, such as audited financial and other information contained in the issuer’s annual, quarterly, and current reports, as well as press releases and other public disclosures published by the issuer, as required by U.S. federal securities laws and stock exchange and Nasdaq requirements. Meetings with senior executives are a common aspect of the credit rating procedure. The goal of these meetings is to go over the company’s major operating and financial strategies, as well as management policies and other credit issues that could affect the credit rating.
As previously stated, the rated company is required to provide Standard & Poor’s with complete, timely, and trustworthy information on an ongoing basis as part of the surveillance process.
Standard & Poor’s also expects rated companies to notify them promptly of any major changes to previously submitted information, as well as any material financial or operational changes that may affect their credit ratings.
Contact with management on a regular basis is also part of the rating surveillance procedure.
The lead analyst contacts the rated company on a regular basis to discuss its performance and advancements.
A meeting between Standard & Poor’s rating analysts and the company’s management would be held if the company’s performance or developments differ significantly from forecasts, or if a significant, new transaction is anticipated.
The frequency or extent of engagement with management is determined by the risk profile of the company, its size, the amount of debt it owes, and its complexity.
In response to big industry developments, material corporate announcements, or intentions to obtain fresh financings, dialogue with management becomes more regular.
Standard & Poor’s makes considerable use of main and third-party databases as a source of supplementary information in addition to information provided by the company.
Third-party data providers provide a reliable source of up-to-date financial data on the domestic insurance and banking industries, as well as the corporate sector and the asset-backed and residential mortgage sectors.
The Federal Deposit Insurance Corporation, the National Association of Insurance Commissioners, the United States Census Bureau, the Institute for Real Estate Management, and the Mortgage Bankers’ Association are among the other sources of information.
Information that is to be kept private.
Companies frequently provide non-public information to Standard & Poor’s during the credit rating process and ongoing surveillance, such as budgets and forecasts, standalone financial statements, internal capital allocation schedules, contingent risk analyses, and information relating to new financings, acquisitions, dispositions, and restructurings.
Standard & Poor’s has a rigorous policy of maintaining the confidentiality of such information.
The rating reason will not reveal confidential information, even if the rating is made public.
The repercussions of any non-public information evaluated by Standard & Poor’s are conveyed in published rationales, thereby providing the foundation for the rating decision without disclosing non-public information.
The Commission specifically excluded the transmission of confidential information to credit rating agencies from coverage under Regulation FD under the Securities Exchange Act of 1934, citing the common practice of issuers providing confidential information to credit rating agencies as part of the credit rating process.
This exception is consistent with the broad exemption from Regulation FD for the disclosure of nonpublic information to a person who specifically agrees to keep it confidential.
The particular exemption from Regulation FD for confidential information submitted to credit rating agencies merely removed any doubt about the structure of the parties’ confidentiality agreement.
Credit Ratings and Rating Actions are disseminated.
Standard & Poor’s has a long-standing policy of making its public credit ratings and the data that underpins them freely available to the investing public.
Public credit ratings (which account for 99 percent of Standard & Poor’s credit ratings in the United States) are disseminated through real-time postings on the Standard & Poor’s website, a wire feed to the news media, and subscription services like Ratings Direct and Credit Wire.
Any caller to Standard & Poor’s Rating Desk can also ask for a rating and receive a report.
Prior to the investing public, subscribers do not have access to ratings or rating actions.
All changes to public credit ratings, as well as all CreditWatch and Outlook listings, are rapidly communicated following notification to the issuer via Standard & Poor’s website, worldwide press releases to wire services, and subscription services such as RatingsDirect and CreditWire.
The reasons for credit rating changes are published in news releases, the most relevant of which may be found on Standard & Poor’s website.
Additional Publications.
Communication with the public is very important to Standard & Poor’s.
It issues reports and rationales on a regular basis that inform the market about an issuer’s strengths and weaknesses, as well as relevant developments that may impact the issuer’s creditworthiness.
Standard & Poor’s issues roughly 11,000 press releases each year, over 1,700 articles and commentary pieces on sector and industry trends, 51 editions of Credit Week (a weekly print publication on fixed-income instruments), and 12 sector reports on 19 industry groupings around the world.
Standard & Poor’s holds around 200 investor telephone conferences each year, sponsors investor forums, and does hundreds of print and television interviews on fixed income subjects.
Conflicts of Interest and Other Potential Problems
As previously stated, both the actuality of, and the public’s confidence in, the independence, objectivity, and credibility of any credit rating agency’s credit ratings and rating methodology are critical to its credibility and the market’s use of its credit ratings. Standard & Poor’s is dedicated to upholding the value of the ratings franchise it has developed throughout its 86-year existence by adhering to these values. The policies guiding the conduct of Standard & Poor’s credit ratings professionals, as well as the structure and functioning of the credit ratings business, reflect these values.
Codes of Ethics
The Standard & Poor’s Credit Market Services Guidelines and Procedures and Code of Ethics, as well as the McGraw-Hill Code of Business Ethics, apply to all Standard & Poor’s credit ratings staff.
- honest and ethical behavior, including potential or perceived personal and professional conflicts of interest;
Employees of Standard & Poor’s credit ratings are subject to particular restrictions on securities ownership and prohibitions on relationships that could create a potential conflict of interest in their credit rating job. Employees are not allowed to own stock in companies with whom they deal often or vote at rating committee meetings. Employees must report all stock ownerships, accounts, and other potential conflicts of interest on an annual basis, as well as any changes in their portfolio information or potential conflicts of interest within five business days after the transaction or occurrence that triggered the potential conflict. Furthermore, employees at Standard & Poor’s are bound by provisions in McGraw-policies Hill’s that prohibit any employee whose responsibilities include reporting on an industry or evaluating securities from having any relationships with companies in these industries that could compromise or appear to compromise the objectivity of the employees’ reports or evaluations, and that require advance disclosure to supervisors of any such potential relationships.
All non-public information about an issuer or an issue collected by Standard & Poor’s credit ratings staff in the course of their work must be kept confidential, according to the company’s Code of Ethics.
The Code of Ethics contains extensive guidelines for maintaining information confidentially.
Standard & Poor’s has developed strict firewalls to ensure the confidentiality of non-public customer information made available to them during the credit rating process.
Such non-public information is not shared with any other McGraw-Hill business unit or Standard & Poor’s non-ratings business, nor is it shared with any third party without the issuer’s approval.
According to McGraw-Code Hill’s of Business Ethics, infractions must be reported, and Standard & Poor’s Guidelines and Procedures must be confirmed annually.
Process of Credit Rating.
Standard & Poor’s credit ratings are assigned by rating committees rather than individuals to ensure maximum impartiality, fairness, and in-depth studies.
Standard & Poor’s also requires that any meeting with a company’s management be attended by at least two analysts.
Standard & Poor’s also has a large corporate infrastructure committed to guaranteeing the credit ratings’ independence, objectivity, and consistency.
An Analytic Policy Board made up of senior practice leaders and criteria officers meets on a regular basis to examine policies, methods, and criteria, as well as any gaps or departures from them.
The Chief Credit Officer and Chief Quality Officer at Standard & Poor’s are senior executives who are responsible for maintaining the quality, consistency, and objectivity of credit ratings.
Structure of the company.
Standard & Poor’s credit rating services are run as a separate entity from the company’s non-ratings operations.
Personnel from Standard & Poor’s credit ratings are not involved in any business activity outside of Standard & Poor’s credit ratings business, either directly or indirectly.
Standard & Poor’s credit rating services have strong operational safeguards and rules in place to ensure operational independence, both in fact and appearance.
Furthermore, as previously indicated, strong firewalls are in place to secure confidential information given to credit rating personnel and to prohibit communication to non-ratings staff.
Fees for credit ratings.
Standard & Poor’s has charged issuers for credit rating services since 1968.
The method was implemented in response to rising credit rating monitoring expenses and a growing demand for more ratings coverage.
Prior to it, Standard & Poor’s charged membership fees for its credit ratings services, which were insufficient to cover the increased costs of maintaining a high level of quality in this industry.
No part of an analyst’s pay is based on the performance of the firms he or she rates or the amount of fees paid to Standard & Poor’s by those companies.
Furthermore, while Standard & Poor’s does business with over 37,000 issuers, individual issuers’ influence on the company is minimal.
Most crucially, the credit ratings business of Standard & Poor’s is entirely reliant on market faith in the legitimacy and reliability of its credit ratings.
There is no one issuer fee or collection of fees that is significant enough to jeopardize the agency’s reputation or future.
Regulatory Treatment of Credit Rating Agencies
Under broad First Amendment protections, credit rating companies are now free to establish and publish their credit rating opinions. Indeed, judicial acknowledgment of major First Amendment protections provided to Standard & Poor’s has been based on the company’s key function as a publisher of credit ratings and financial information.
Given the critical role that credit rating agencies play in the securities markets, Standard & Poor’s recognizes that the Commission has a legitimate interest in reviewing the conduct of credit rating agencies at this critical time for the U.S. securities markets to ensure that the credit rating process is not tainted by conflicts of interest, misuse of confidential information, or other dishonest or fraudulent behavior.
Standard & Poor’s anticipates that after the Commission completes its current review, it will find that the credit rating industry’s independence, objectivity, and integrity have not been jeopardized, and that there is no compelling investor protection need to impose a new regulatory regime directly regulating credit rating agencies and the credit rating process.
Due to the inclusion of NRSRO security ratings in the Commission’s rules and regulations, Standard & Poor’s also acknowledges that the Commission has a legitimate interest in credit ratings and credit rating agencies to the degree they are recognized or seek recognition as an NRSRO.
Although Standard & Poor’s has typically opposed the use of NRSRO ratings in Commission rules, it recognizes that no other authority, including the Commission, has discovered a feasible alternative for evaluating credit risks associated with debt and other rated securities for regulatory purposes.
Indeed, credit ratings were created in response to private market demand in the securities markets, and the capital markets have yet to produce a widely accepted alternative method for making such distinctions.
In 1976, the Commission designated Standard & Poor’s as one of the first NRSROs.
The designation was based on the Commission’s acknowledgment of widespread investor acceptance of Standard & Poor’s credit ratings, which reflected the market’s trust in the firm’s independence, objectivity, trustworthiness, and transparency.
Standard & Poor’s thinks that the marketplace benefits from a diversity of reliable credit information sources, and that any Commission regulation action involving credit rating agencies should focus on addressing concerns about the lack of openness in the process of designating NRSROs.
Standard & Poor’s has long advocated for a more open, transparent designation process that codifies an administrative process that allows the public to participate on future designations.
However, when codifying the NRSRO designation process, great care must be given to ensure that designation criteria are not stated in a way that interferes with or compromises the credit rating process’ independence.
The ability of a credit rating agency to demonstrate pre-existing market recognition and financial market use of its credit ratings should continue to be the key condition for designation as an NRSRO.
A credit rating agency could show evidence of the credit ratings’ importance to specific participants or segments of the market, as well as the extent of its ratings’ dissemination among investors, issuers, intermediaries, and other market participants, such as analysts and the financial and trade media, in order to demonstrate that it meets these marketplace criteria.
The credit rating agency could, for example, provide evidence of the type and number of U.S. subscribers to its ratings, the number of ratings assigned annually, the number of issuers or others who request ratings, and evidence that securities rated by the credit rating agency are owned or traded by U.S. investors who are aware of the credit rating agency’s rating of such securities.
In addition, Standard & Poor’s thinks that the Commission should consider material pertaining to the credit rating agency’s independence, objectivity, transparency, and credibility as part of its NRSRO designation process.
In this regard, the Commission could look into the credit rating agency’s policies on conflicts of interest and the protection of confidential information, as well as its practices regarding credit rating publication, rating definitions and general descriptions of its rating criteria and methodology, code of ethics, and default studies demonstrating the credit rating agency’s track record.
In addition, such a study could take into account aspects affecting economic and political independence, such as ownership and organizational structure, as well as the lack of reliance on major clients.
The Commission should not be involved in the conduct of an NRSRO’s operations, interfere with its credit rating methods or methodologies, or impose regulated entity status on a designated NRSRO, according to the NRSRO designation process and criteria.
Staffing, financial resources, and organization adequate to provide trustworthy ratings, use of systematic rating procedures, and communication with senior executives of rated firms have all been advocated by the Commission in the past as designation requirements.
The suggested addition of subjective criteria relating to resources, fees, methodology, and processes would neither ensure market credibility and acceptance of credit ratings, nor would it improve the transparency of the designation process, given their inherently imprecise and subjective nature.
Furthermore, such criteria could imply that the Commission should play a role in establishing minimum capital, organizational, and staffing requirements for NRSROs, potentially resulting in governmental interference in the credit rating process or rating judgments.
The Commission has also proposed that NRSROs be required to register as investment advisers under the 1940 Investment Advisers Act (“Advisers Act”).
Standard & Poor’s argues that NRSROs are not investment counselors and that credit ratings are not financial advice from a legal standpoint.
Furthermore, the Advisers Act’s regulations and rules are intended to safeguard investors when it comes to investment counseling and investment management, which are activities that are completely unrelated to credit rating services.
The Adviser’s Act was “intended to apply to those persons engaged in the investment-advisory profession – those who provide tailored advise attuned to a client’s needs,” according to the Supreme Court in Lowe v. Securities and Exchange Commission.
The court made a clear distinction between investment counselors who have a fiduciary duty to their customers and those who simply provide impersonal remarks about a security.
Investors must realize that a credit rating does not represent investment advice with respect to a rated security; they should not be led to believe that a credit rating provides advise on the rated security’s worth as an investment or the appropriateness of its market valuation.
Investors may wrongly believe that a credit rating represents advice on whether to purchase, sell, or hold a securities, or that they can rely on a credit rating organization as a fiduciary, neither of which is true.
Given the Advisers Act’s regulatory provisions’ general lack of applicability to credit rating agencies, it’s unclear what investor interest or regulatory objective the Commission hopes to achieve by registering NRSROs as investment advisers.
Conclusion
Credit rating agencies have played an important role in the development of the US capital markets, as well as the capital markets around the world, over the last century. The market’s acceptance of their integrity, independence, objectivity, and credibility has been critical to their unique and valuable role in the market’s development. The Commission must provide a framework that preserves credit rating agencies’ independence and recognizes the market as the best judge of a credit rating agency’s quality, objectivity, and independence if it is to continue playing this important role and extend the benefits of independent, credible rating services internationally.
There is no evidence of market failure or abuse that justifies abandoning the regulatory framework that has served investors and the market so well for so long.
Adoption of direct regulation or use of NRSRO designation criteria by the Commission that suggests a substantive role for government in credit rating agencies’ business operations or the rating process is likely to be followed by other markets and implemented in a way that results in governmental intrusion into the actual rating process – a result that could erode credit rating agencies’ independence and, as a result, their credibility.
Standard & Poor’s appreciates the opportunity to speak at the Commission’s public hearings and looks forward to continue the conversation with the Commission and the market.
Why is it necessary for a corporate bond to be rated by a third-party rating agency?
It assesses a bond issuer’s financial strength and ability to repay principal and interest in accordance with the terms of the contract. Short- and long-term debt obligations, as well as securities, loans, preferred shares, and insurance companies, can all be awarded ratings.
How are rating agencies used to determine a bond’s risk?
However, it is widely assumed that AAA and AA-rated securities have a default risk of less than 1%, with the likelihood of default increasing with each succeeding rating.
Typically, credit rating companies have analysts who recommend a rating, followed by a committee that votes on the recommendation. Background data, management predictions, risk reports, and performance forecasts will all be used by analysts.
They can also take into account macroeconomic statistics, data provided by a corporation, bank, or government, or other publicly available information regarding the asset being evaluated for a rating. There will be a pre-committee and then a committee stage if the analysts have gathered enough data and information to make a recommendation.
The purpose of the pre-committee stage is to determine if the whole rating process should proceed; if there is insufficient information to make a recommendation, the ratings process may be halted. If the process is agreed to continue, the recommended rating will be forwarded to a committee for review.
A review package containing the analysts’ findings and explanation for a suggested rating is frequently submitted to the committee. The committee will look over the results in the review package and decide whether the experts’ recommendation is right.
The ratings are also only ever published as the opinions of a single agency, but market players will combine the opinions of numerous agencies to establish an aggregate credit risk rating.
What is the significance of bond ratings to businesses and investors?
Credit rating agencies are the ones who publish the ratings. Rating Organization A rating agency evaluates a company’s or government entity’s financial strength, particularly their ability to meet principal and interest payments, and provides assessments of a bond issuer’s financial strength and ability to repay the bond’s principal.
Why do rating organizations give commercial paper ratings?
Why do rating organizations give commercial paper ratings? -Ratings are assigned to commercial paper to indicate the degree of default risk. Commercial paper issuers must pay for rating services in order to have their paper rated.
Why do businesses want a high bond rating over a lesser bond rating on their debt securities?
In general, the higher the bond rating, the better the bond issuer’s terms will be. Because investors want less compensation for the risk of default, high-rated bonds have lower interest rates. Bond issuers will have cheaper borrowing costs as a result of this.
In bond ratings, however, there is one very significant breakpoint. Bonds rated BBB- or Baa3 or higher are considered investment grade, which implies they can be owned by most institutional investors. Bonds rated BB+ or Ba1 or lower, on the other hand, are classified as high-yield bonds, sometimes known as trash bonds. Because these are considered to be more speculative, many institutional investors avoid them or have investment limits.
Bond ratings aren’t always accurate predictors of what will happen with a given bond, and ratings haven’t always worked as intended. Bond ratings, as a measure of relative strength, are an excellent place to start when researching a company’s debt.
Why do we need a third party to assess the creditworthiness of a bond?
Third-party rating firms decide bond ratings. This helps to keep bond evaluations impartial and independent. Although the general scales are supposed to be identical, the three major rating agencies – Fitch, Standard & Poor’s, and Moody’s – give slightly different ratings to bonds.
Rating agencies are not government agencies; they are for-profit businesses in their own right. Bond ratings are assigned by Moody’s, Standard & Poor’s, and Fitch in exchange for cash payments. This is one of the ways corporations make money for their stockholders.
Why does it matter if a bond issuer has at least two ratings?
That is, issuers utilize several ratings to maximize the likelihood of a true evaluation developing, which might result in their bonds receiving the best potential interest rate.
What role did rating agencies play in the financial crisis?
The credit rating companies’ role in the financial crisis has been widely criticized and largely unaccountable. The agencies have been accused of inflating the ratings of dangerous mortgage-backed securities, giving investors the misleading impression that they were safe to invest in. In an op-ed for The New York Times, columnist Paul Krugman wrote, “While attacking credit rating agencies in an op-ed for The New York Times, “As a result of the distorted assessments, the financial system was able to take on far more risk than it could safely handle.” The Financial Crisis Inquiry Commission determined in 2011 that these rating firms were involved in the financial crisis “were crucial enablers of the financial crisis.”