By Staff Writers, Bulls and Bears Press
Standard & Poor’s, Moody’s and Fitch Ratings - what do these three companies have in common? They are the three major global ratings agencies (comprising 90-95% of market share). They provide the service of rating debt, both on the corporate and the consumer level, to facilitate investment decisions and provide some market transparency.
When a company wishes to issue debt for a given project, or to roll over debt, they depend on ratings agencies to help set an interest rate. The ratings agencies, by reviewing a company’s historical financials, as well as current assets and liabilities (and other factors, such as current management, project viability, etc.), create a bond rating to help investors gauge their potential investments. The accepted low-risk credit rating is AAA (from S&P and Fitch, Aaa at Fitch Ratings), implying that bonds with this rating are very unlikely to default, making them a safe long term investment at a low interest rate. All three agencies have a given high-risk rating of C or D, indicating a very likely default in the near future (the ratings signify the company has failed to pay a recent debt obligation). These high risk bonds will intuitively pay higher interest rates. Debt ratings can be bond-specific or set for the company, depending on what type of bond is being issued.
Problems began to arise for ratings agencies during the early 1970s, when payment of the agencies shifted. Prior to the 1970s, ratings agencies were predominantly paid by investors seeking investment stability. Through this structure, there were no questions regarding the impartiality of ratings provided by major agencies. However, since the 1970s, ratings agencies have been paid by companies issuing the debt. So if Boeing wishes to issue a series of bonds to finance the development of a new airplane, they will pay Standard & Poor’s, Moody’s, or Fitch Ratings to examine the project and issue a rating. This process has come under scrutiny, and the SEC has attempted to increase regulation as a result.
Ratings agencies don’t solely cover corporations; their coverage extends to countries as well. Currently, United States Treasury Bills are AAA-rated by all three credit ratings. However, countries around the world face different ratings. When ratings agencies change debt ratings for countries (as has recently become fairly frequent, especially in Europe), the country is forced to pay different interest rates. This affects not only their bond issuancesbut their Credit Default Swap (bond insurance) spreads, as well. Seeing as many countries rely on the continual issuance of new debt in order to operate (the U.S. included), a debt rating downgrade can cripple a country and force borrowing rates above economically feasible levels. This, in some cases, leads to a case where the country cannot afford to borrow at the rates the market demands and is forced to ask for a bailout (as Greece, Ireland, and Portugal recently experienced).
Regardless of the scrutiny ratings agencies have received in the past years, their necessity is still evident. Debt rating changes affect markets around the world on a daily basis, and their impact proves their worth, or at least the fervor with which people follow them.
