credit rating agencies

(noun)

A credit rating agency (CRA) is a company that assigns credit ratings to issuers of certain types of debt obligations, as well as to the debt instruments themselves.

Examples of credit rating agencies in the following topics:

  • Ratings

    • Bond credit rating agencies assess and report the credit worthiness of a corporation's or government's debt issues.
    • The credit rating is analogous to a credit rating for individuals.
    • The ratings are assigned by credit rating agencies, such as Moody's, Standard & Poor's, and Fitch Ratings, and are given in letter designations (AAA, B, CC), which represent the quality of a bond.
    • These are bonds that are rated below investment grade by the credit rating agencies.
    • Until the early 1970s, bond credit ratings agencies were paid for their work by investors who wanted impartial information on the credit worthiness of securities issuers and their particular offerings.

  • Bond Rating System

    • The credit rating is a financial indicator assigned by credit rating agencies; bond ratings below BBB-/Baa are considered junk bonds.
    • It is analogous to credit ratings for individuals.The credit rating is a financial indicator to potential investors of debt securities, such as bonds.
    • These are assigned by credit rating agencies such as Moody's, Standard & Poor's, and Fitch Ratings to have letter designations (such as AAA, B, CC), which represent the quality of a bond.
    • Credit rating agencies registered as such with the SEC are "Nationally recognized statistical rating organizations. " The following firms are currently registered as NRSROs: A.M.
    • Generally, they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them.

  • International Credit Rating Agencies

    • International credit-rating agencies do not focus on risk for particular companies but assess investment risk associated with countries.
    • Two well-known credit agencies are A.M Best and Coface.
    • Best is an international credit agency that classifies country risk into five tiers.
    • Table 2 shows a country's rating for 2012.
    • Coface, France's export credit underwriter, is another international credit-rating agency.

  • Securitization and the 2008 Financial Crisis

    • Credit-rating agencies could rate some bonds as AAA that pays the lowest return to investors, but investors are first in line if the fund goes bust.
    • Credit-rating agencies, such as Standard & Poor, and Moody's conspired with theinvestment banks.
    • Credit agencies always rated CDOs with an AAA credit rating, even though some CDO's funds contained subprime mortgages.
    • Credit-rating agencies were either incompetent or perpetuating fraud.
    • The AAA credit rating became vital for bankers to sell the CDOs.

  • Price Risk

    • Interest rates and bond prices carry an inverse relationship.
    • Fixed-rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise.
    • When the market interest rate rises, the market price of bonds will fall, reflecting investors' ability to get a higher interest rate on their money elsewhere — perhaps by purchasing a newly-issued bond that already features the new higher interest rate.
    • On the flip side, if the prevailing interest rate were on the decline, investors would naturally buy bonds that pay lower rates of interest.
    • Bond prices can become volatile depending on the credit rating of the issuer – for instance if the credit rating agencies like Standard & Poor's and Moody's upgrade or downgrade the credit rating of the issuer.

  • Measuring Country Risk

    • Investors protect themselves from credit risk by increasing the borrower's interest rate.
    • Consequently, credit-rating agencies measure a borrower's risk.
    • Analysts and economists measure a country's risk similarly, applying the same credit rating rules.
    • Furthermore, a credit-rating agency rated the Mexican government a letter grade of BBB that equals a spread of 140 basis points (bps).
    • We show a country's credit rating and spread in Table 1.

  • Disadvantages of Bonds

    • Bonds are subject to risks such as the interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
    • Fixed rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise.
    • When the market interest rate rises, the market price of bonds will fall, reflecting the ability of investors to get a higher interest rate on their money elsewhere — perhaps by purchasing a newly issued bond that already features the newly higher interest rate.
    • Bonds are also subject to various other risks such as call and prepayment risk, credit risk, reinvestment risk, liquidity risk, event risk, exchange rate risk, volatility risk, inflation risk, sovereign risk, and yield curve risk.
    • Bond prices can become volatile depending on the credit rating of the issuer – for instance if credit rating agencies like Standard and Poor's and Moody's upgrade or downgrade the credit rating of the issuer.

  • Depository Institutions

    • For example, if you borrowed $10,000 at a 5%, interest rate and loaned it out at 10%, then you earn a profit.
    • However, if you borrowed $10,000 at 10% interest rate and loaned it out at 5%, subsequently, you earn a loss.
    • Interest rates rose during the 1980s as the savings institutions paid a greater interest rate to thedepositors than the amount of these institutions earned on the mortgages. mortgages are usually 30-year loans, and savings institutions were locked into low interest rates from the 1960s.
    • Currently, savings institutions are similar to banks, except different government agencies regulate the savings institutions.
    • Credit unions are another depository institution.

  • Answers to Chapter 10 Questions

    • Banks use credit risk analysis, collateral, credit rationing, and restrictive covenants to reduce adverse selection.
    • Floating rate debt is loans with a variable interest rate.
    • If the interest rate increases, then borrowers must pay more interest on their payments.
    • A fund offers different tranches with different credit ratings and rates of return.
    • If banks retained their rigid lending standards and the creditrating agencies accurately rated the CDOs and ABS, then the housing bubble would still form but at a slower rate.

  • The United States Banking System

    • If this agency insures, then it also regulates.
    • Thus, they have their own regulatory agencies.
    • Most credit unions have charters from the National Credit Union Administration, which issues charters on the federal government's behalf.
    • This agency also insures the deposits at credit unions while the FDIC does not.
    • If the central bank uses the money supply to influence the inflation, business cycle, or interest rates, the central bank also affects the financial markets.