How does The Rating Evaluation System Work?

Comparative Analysis of The Evaluation Systems Used by The Main Rating Agencies in The World

Introduction

First and foremost, what is a rating agency? Let’s say you want to lend a company some money and get the profit back out of it. You lend that money by buying bonds, which are debt instruments created for the purpose of raising capital, indicating the amount lent, the runtime and the interest rate on it. They get the money and you get your bond. When the arranged time is passed, you get your money back plus an interest on top.

In case that company runs bankrupt, your money will be gone for good. That’s why it is important to find out if the company is insolvent or solvent.

Rating Agency Definition

Credit rating agencies are the companies that analyze the debt situation of a bond issuer and after running all their numbers, they give it a credit rating. A rating agency scales ranges from D, C, CC, CCC, B, BB, BBB, A, AA, and AAA. AAA means your money is safe and C or D is unsafe.

Rating agencies are the foundation of global finance. Without rating agency regulations, lenders act in blind faith as there will be no way how to quickly know how secure a bond is. There are 3 big rating agencies in the world and they include; Standard & Poor’s, Moody’s and Fitch Group.

Standard & Poor’s

Standard & Poor’s, popularly known with its corporate name as S&P Global, is a global market intelligence company that provides the best decision making processes for companies and investors around the world to make decisions with conviction.

S&P is a big corporation that has an economic benchmark and analytics which enables them to set the world in motion. It provides credit ratings on financial instruments such as bonds, to countries, investment and commercial banks, wealth manager, corporations and generally institutional investors.

S&P Global Index

S&P Global has indices that provide leading market insight to individuals and institutions so they can evaluate the performance of their investments. From the most complex investment strategy to the most basic retirement portfolio. This happens in one of the units based on the market known as S&P Dow Jones Indices which is basically the world’s resource and reference for index-based concepts, statistics, and research.

S&P Rating Agency Regulations

Their credit ratings and research provide transparency for investors looking to make key decisions for growth. S&P’s Global data supported with relevant news and research arms financial professionals with essential insights to capitalize on market opportunities.

The ratings are a credit score that describes the approval or creditworthiness of the organization that assigns debt. Usually, S&P would seek data and research from publications such as annual reports, press releases, interviews on the companies and legitimate news articles.

The analysts would then come up with assessments of the company’s financial status, ROCE (Returns on Capital Employed) and company strategies. When the company had just started and there were no copy machines, these reports used to be sold to the investors. But with time it changed its policy to start charging the investors directly as it was believed that those companies shared the information with others.

S&P Global issues bond ratings for 130 countries in the world. The company scrutinizes how deep the country can repay its national debt by checking stability in fiscal policies, economic growth and expansion, and finally foreign investments. That way, the company will be able to know if the central bank is independent of its government and uses good financial policies.

The S&P 500, which is a stock market index, reflects the risk and return of 500 large-cap U.S. companies on the New York Stock Exchange and NASDAQ.

Moody’s

Moody’s Investor Service, popularly known as Moody’s, is a bond credit rating agency in USA of Moody’s Corporation. Moody’s corporation is a financial service company which is the holding company to MIS (Moody’s Investor Service) and MA (Moody’s Analytics), which provides software and research for economic evaluation and managing of risks.

Moody’s is recognized in the US as a Nationally Recognized Statistical Rating Organization (NRSRO)

Moody’s Ratings Definitions

The original thought of Moody’s ratings was to enable an easier assimilation of grading by which future creditworthiness and prospects of securities may be levelled from.

Moody has two segments of rating. It includes of the normal alphabetical order Aaa, Aa, A, Baa, Ba, B, Caa, Ca and C. The other category is the numerical order; 1, 2 and 3. For example, you would have Aa1, Aa2, Aa3 and so on and so forth.

Moody’s Rating agency scale comparison

Aaa – highest quality with minimal risk.

Aa – high quality and likely to have very low credit risk.

A – upper-medium-grade and likely to have low credit risk.

Baa – moderate credit risk, medium-grade and may possess speculative characteristics.

Ba – speculative and likely to have high credit risk.

B – speculative and subject to high credit risk.

Caa – poor standing and likely to have very high credit risk

Ca – highly speculative with some characteristics of recovery in principal and interest

C – the lowest class in default mode with barely any characteristics for principal and interest.

1 – superior ability to pay short-term debt commitments

2 – strong ability to pay short-term debt commitments

3 – acceptable ability to pay short-term debt commitments

Moody’s Rating agency regulation

Like any rating agency, Moody’s agency has regulatory affairs which can be further be explained in this link.

Rating Agency Europe

It has a transparency report that showcases the events leading to the period that has been stated.

Fitch Ratings

Rating Agency Fitch is a global rating agency committed to providing the world’s credit markets with independent and potential credit opinions, research and facts and figures. It is one of the Nationally Recognized Statistical Rating Organization (NRSRO) appointed by the US Securities and Exchange Commission.

Amongst the big three, Fitch Ratings occupies the least market share but is situated in New York in America, just like the other two, and in Europe in London, England.

Fitch Ratings Scale

Fitch ratings long-term credit ratings are configured with an alphabetic order from ‘AAA’ to ‘D’. ‘AAA’ to ‘BBB’ are investment grades and ‘BB’ to ‘D’ are speculative grade. Investment grade classifications indicate comparatively low to moderate credit risk, while ratings in the speculative classifications either depict a higher level of credit risk or that a default has already occurred.

Fitch Ratings and Sovereign Nations

Fitch offers sovereign credit ratings which basically show how each nation’s capability is in meeting its debt commitments. Sovereign credit ratings are availed to investors to help them with intuition into the level of risk that can occur when you invest in a particular country. Countries will welcome Fitch and other credit rating agencies to assess their economic and political stability and financial power to come up with the best rating. For developing nations, it's crucial to have the best sovereign credit rating possible as it helps in being qualified for funding in international bond markets.

Credits: Marco Barchetti - Co-Founder Fintech.Review