Credit Ratings

Credit Ratings

Definition of Credit Rating: Credit Rating is a qualified assessment and formal evaluation of company’s credit history and capability of repaying obligations. It measures the default probability of the borrower, and its ability to repay fully and timely its financial debt obligations. The main purpose of credit rating is to provide investors with comparable information on credit risk based on standard rating scale, regardless of specifics of companies, separate sector of the economy and country as a whole.

Three credit rating agencies are recognized worldwide: Standard & Poor’s, Moody’s Investor Service, Fitch Ratings. They assign domestic and external ratings at the borrower’s request. Each of them is present in most of the countries and has a universal rating scale.

Factors involved in credit rating
Credit rating depends on several factors, some of which are tangible/numerical and some of which are judgmental and intangible. Some of these factors are listed below:

• Overall fundamentals and earnings capacity of the company and volatility of the same
• Overall macro economic and business/industry environment
• Liquidity position of the company (as distinguished from profits)
• Requirement of funds to meet irrevocable commitments
• Financial flexibility of the company to raise funds from outside sources to meet temporary financial needs
• Guarantee/support from financially strong external bodies
• Level of existing leverage (borrowings) and financial risk

The Raters
There are three top agencies that deal in credit ratings for the investment world. These are: Moody's, Standard and Poor's (S&P's) and Fitch IBCA. Each of these agencies aim to provide a rating system to help investors determine the risk associated with investing in a specific company, investing instrument or market.

Standard & Poor’s was established in 1860 by Henry Varnum Poor.  The agency’s founding principle was “the investor has the right to know”.  The company provided independent financial analysis and information worldwide.

In 1906, Standard Statistics Bureau Company was formed to provide previously unavailable financial information on US companies. In 1916, Standard Statistics Bureau began to assign debt ratings to corporate bonds and sovereign debt. Municipal bond ratings have been introduced in 1940.

In 1941, Poor’s Publishing and Standard Statistics merged to form the Standard & Poor’s Corporation.

In 1966, The McGraw-Hill Companies, Inc. acquired Standard & Poor’s. Today Standard & Poor’s is a division of Corporation, which provides financial consulting, credit ratings, numerous analytical materials on securities, companies, banks (Bond Guide, Earnings Forecaster, New Issue Investor, Stock Guide, Analyst’s Handbook, Corporation Records, Poor’s Register, Securities Dealers of North America).

Now the company has 21 offices and 1,200 analysts, including some of the world’s foremost economists.

 Moody’s Investor Service. A leading global credit rating, research and risk analysis firm that publishes credit opinions, research and ratings on fixed-income securities, issuers of securities and other credit obligations.

The company was established in New York by John Moody in 1900. Initially John Moody & Company published Moody’s Manual of Industrial and Miscellaneous Securities. The manual provided information and statistics on stocks and bonds of financial institutions, government agencies, manufacturing, mining, utilities and food companies.

In 1909, Moody’s Analysis of Railroads Investments described for readers the analytic principles that Moody used to assess railroad’s operations, management, and finance.

In 1913, the company expanded its base of analyzed companies, launching the evaluation of industrial companies and utilities. The Moody’s ratings have become a factor in the bond market.

On July 1^st, 1914, Moody’s Investor Service was incorporated.

By 1924, Moody’s ratings covered nearly 100% of the US bond market.  Moody’s continued to publish and monitor ratings during the Great Depression.

In the 1970s, the Moody’s ratings were further extended to the commercial paper market and to bank deposits.

Now, Moody’s Corporation comprises two subsidiaries: Moody’s Investors Service and Moody’s KMV. The corporation, which had reported revenue of $1.0 billion in 2002, employs approximately 2,100 people worldwide and maintains offices in 18 counties.

Moody’s Investors Service is among the world’s most respected, widely utilized sources for credit ratings, research and risk analysis. The firm regularly publishes market-leading credit opinions, deal research and commentary that reach more than 3,000 institutions and 20,000 subscribers around the globe.

Fitch Ratings. Agency provides credit ratings to corporate, municipal bonds, preferred stocks, commercial paper, and to non-commercial organizations. Fitch Ratings was founded as the Fitch Publishing Company on December 24^th, 1913 by John Knowles Fitch in New York City.

The Fitch Publishing Company began as a publisher of financial statistics whose consumers included the New York Stock Exchange. Soon Fitch became the recognized leader in providing critical financial statistics to the investment community through such publications as the “Fitch Bond Book” and the “Fitch Stock and Bond Manual”.

In 1924, Fitch introduced the now familiar “AAA” to “D” ratings scale to meet the growing demand for independent analysis of financial securities.

Fitch was one of the three rating agencies first recognized as a nationally recognized statistical rating organization (NRSRO) by the Securities and Exchanges Commission in 1975.

In 1997, Fitch merged with IBCA Limited, headquartered in London, increasing Fitch’s worldwide presence in banking, financial institutions and sovereigns.  Through the merger with IBCA, Fitch became owned by FIMALAC, Paris, a holding company, which acquired IBCA in 1992.

Fitch has a rating presence in 75 countries and 40 offices worldwide. It today has 1,300 employees, including 725 analysts.

Fitch currently covers 2,300 banks and financial institutions, 1,000 corporate and maintains surveillance on 3,300 structured financings and 17,000 municipal bond ratings in the U.S. tax-exempt market. Fitch also rates over 700 insurance companies plus 70 sovereigns.

Here is a chart that gives an overview of the different ratings symbols that Moody's and Standard and Poor's issue:

Bond Rating Grade Risk Moody's Standard & Poor's AAA AAA Investment Lowest Risk AA AA Investment Low Risk A A Investment Low Risk Baa BBB Investment Medium Risk BA, B BB, B Junk High Risk CAA/Ca/C CCC/CC/C Junk Highest Risk C D Junk In Default

For more information on each ratings agency given below:

Fitch	Moody's	Standard & Poor's	What the Rating Means
Investment Grade
AAA	AAA	AAA	Highest credit quality
AA	AA	AA	Very high credit quality
A	A	A	High credit quality
BBB	BBB	BBB	Good credit quality
Non-investment Grade
BB	BA	BB	Speculative
B	B	B	Highly Speculative
CCC	CAA	CCC	High Default Risk
CC	CA	C	High Default Risk
C	C	C	High Default Risk
DDD	C	D	Default
DD	C	D	Default
D	C	D	Default

Bond Rating: A specification of a bond issuer's probability of defaulting based on an analysis of the issuer's financial condition and profit potential. Bond ratings start at AAA (denoting the highest investment quality) and usually end at D (meaning payment is in default).

Credit Risk is the risk of loss due to a counterparty defaulting on a contract, or more generally the risk of loss due to some "credit event". Traditionally this applied to bonds where debt holders were concerned that the counterparty to whom they've made a loan might default on a payment (coupon or principal).

Default Risk: The risk that companies or individuals will be unable to pay the contractual interest or principal on their debt obligations.

Credit Rating Information Service of India Limited (CRISIL): The oldest rating agency was originally promoted by ICICI. Standard & Poor, the global leader in ratings, has recently taken a small 10% stake in CRISIL.

ICRA: Promoted by IFCI. Moody’s, the other global rating major, has recently taken a small 11% stake in ICRA.
CARE: Promoted by IDBI.
Duff and Phelps: Co-promoted by Duff and Phelps, the world’s 4th largest rating agency.