Significantly, rating agencies are companies that rate the financial strength of governments, government entities and institutions on their ability to borrow and repay loans or their ability to meet principal and interest payments on their debts.
Today, they have become so important and somehow powerful because the majority of investors depend on them for information in order to make investment decisions.
It is important to note that the ratings they assign to governments, government entities or institutions demonstrate the borrower’s ability to honor their debts as agreed.
Although there are other rating agencies, the global credit rating industry is highly concentrated, with the three agencies Moody’s, Standard & Poor’s and Fitch.
Together they control almost the entire market (95%). They also provide the much needed service to borrowers and lenders.
The main companies are Moody’s Investor Services, Standard and Poor’s (S&P) and Fitch Group. Moody’s and S&P are located in the United States and dominate 80% of the international market. Fitch is located in the United States and the United Kingdom and controls approximately 15% of the global market.
Indeed, it is not surprising that the Ministry of Finance is unhappy with Moody’s rating of Ghana’s credit at Caa1, or junk status. Firstly it is based in the United States where some of the global investors reside and also because the United States boasts of having more of the wealthiest investors in the world who are active in the capital market .
Credit rating operations
Each rating agency uses unique letter-based ratings to indicate whether a debt has low or high risk of default or financial stability relative to the issuer.
Usually, debt issuers can be sovereign nations, local and state governments, special purpose institutions, corporations, or non-profit organizations.
While S&P and Fitch have a similar way of assigning their ratings, Moody’s ratings differ a bit.
Credit rating agencies received widespread criticism during the 2008 global financial crisis for failing to assign appropriate ratings to institutions that led to the collapse and subsequent subprime mortgage crisis. . For this reason, they have become very cautious and alert with their ratings.
They have been criticized for failing to identify risks that would have warned investors against investing in certain types of debt such as mortgage-backed securities.
Credit Score Classifications
Ratings are categorized into investment grade and speculative grade.
Investment grade ratings indicate that the investment is considered sound by the rating agency and that the issuer is likely to honor the repayment terms.
Rating agencies usually assign letter grades to indicate ratings.
For example, S&P has a rating scale from AAA (excellent) to D (failing), while Fitch uses AAA (prime or excellent) to D (failing). Moody’s uses a rating scale from Aaa to C (default).
Below are the rating scales of the rating agencies:
|Long term||Long term||Long term|
|A1||A+||A+||Higher median score|
|A2||A||A||Higher median score|
|A3||A-||A-||Higher median score|
|Baa1||BBB+||BBB+||Lower middle level|
|Baa2||BBB||BBB||Lower middle level|
|Baa3||BBB-||BBB-||Lower middle level|
|Ba1||BB+||BB+||Non-investment grade speculative|
|Ba2||BB||BB||Non-investment grade speculative|
|Ba3||BB-||BB-||Non-investment grade speculative|
|Caa3||CC-||CCC||In default with little prospect of recovery|
|California||CC||CCC||In default with little prospect of recovery|
|D||not a word||Fault|
Credit Rating Settings
Credit rating agencies consider several factors such as financial statements, level and type of debt, history of loans and borrowings, ability to repay debt and past debts of the entity before write them down.
Whether it is a sovereign or an institution being assessed, the main factors usually taken into account are
Business analysis or business analysis
Importance of credit rating agencies
Rating agencies have become a benchmark in financial market regulation.
Legal policies require some institutions to hold investment-rated bonds. Bonds are therefore classified as investment grade based on their ratings by these agencies.
Credit rating agencies are so important that they provide risk metrics for various entities and allow financial market participants to more easily assess and understand the credit risk of parties involved in the investment process.
Significantly, their information indicates whether or not a borrower receives a loan. Good credit ratings allow individuals, businesses and governments to borrow easily from financial institutions or public debt markets.
Rating agencies also assess the credit risk of specific debt securities and borrowing entities.
In the bond market, a rating agency provides an independent assessment of the creditworthiness of debt securities issued by governments and corporations.
Ratings are used in structured finance transactions such as asset-backed securities, mortgage-backed securities, and secured debt securities. Rating agencies therefore focus on the type of pool underlying the securities and the proposed capital structure for restructured financial products.
Ultimately, rating agencies also assign ratings to sovereign borrowers, who are the largest borrowers in most financial markets. Sovereign borrowers include national governments, state governments, municipalities, and other state-backed institutions.