Industry Research – Rating Agency
1) What is the credit agency?
A credit rating is an independent assessment of the creditworthiness of a bond (note or any security
of indebtedness) by a credit rating agency. It measures the probability of the timely repayment of
principal and interest of a bond. Generally, a higher credit rating would lead to a more favorable
effect on the marketability of a bond. The credit rating symbols (long-term) are generally assigned
with "triple A" as the highest and "triple B" (or Baa) as the lowest in investment grade (See below
for definition of rating grades). Anything below triple B is commonly known as a "junk bond."
There are some credit rating agencies such as Moody's Investor Services, Standard & Poor's
Corporation and Fitch rating etc.
2) Why the credit agency exists
Reduce asymmetry between lenders and borrowers
Enhance transparency and efficiency in the fixed-income securities market
3) How are bonds rated?
There are 6 steps:
1) The rating process begins with an application to the rating agencies by the issuer or its agent
either via a telephone call or in writing.
2) The rating agencies rate issuer's debt instruments for decades
3) The rating request is usually done several weeks before the issuance of the bonds to allow time
for the rating agencies to perform their review and analysis.
4) The issuer need to provide the following documentations to the rating agencies as soon as
possible:
the
preliminary official statement;
audited and unaudited financial statements:
the latest budget information, including economic assumptions and trends;
capital outlay plans;
the bond counsel opinion addressing the authority and tax-exempt status of the bond issuance;
all legal documents relating to the security for the bonds; and
any other documents that may pertain to the bond issuance as requested by the rating
agencies.
latest
5) a meeting is set up at the rating agency's or issuer's office to present the credit worthiness. The
credit analyst prepares a municipal credit report which discusses key analytical factors. The credit
analyst presents credit for "sign-off" with the senior analyst and makes a recommendation for
rating. The credit analyst makes a presentation before a rating committee comprised of senior
analysts.
6) the rating is released to the issuer, then to a wire service, followed by a publication of full credit
report.
4) How does rating agency determine?
There are the several elements involved in determining a credit rating, which are:
Economic Factors
Evaluation of historical and current economic factors
Economic diversity
Response to business cycles
Economic restructuring
Assessing the quality of life in the given area
Debt/Issue Structure
Economic feasibility and need for project
Length of bond’s maturity, short-term debt financing
Pledged security and other bondholder protections
Futuristic outlook: capital improvement plan
Financial Factors
Sufficient resources accumulated to meet unforeseen contingencies and liquidity requirements
On-going operations are financed with recurring revenues
Prudent investing of cash balances
Ability to meet expenditures within economic base
Management/ Structural Factors
Organization of government and management
Taxes and tax limits
Clear delineation of financial and budgetary responsibilities
Expanded Analytical Topics
Investment Policies and Practices
Portfolio composition-credit risk, diversification, and market risk
Leverage-increase of assets to enhance yield
Liquidity Management-portfolio maturity profile that matches cash flow
Infrastructure needs
Willingness to Pay
Effective and timely budget response
Willingness to bring budget into balance and still pay debt
Willingness to make payment
5) Credit Rating Information
Bond Ratings
Very High Quality
AAA AA
High Quality
Speculative
Very Poor
Standard &
A BBB
BB B
CCC D
Poor’s
Moody’s
Aaa Aa
A Baa
Ba B
Caa C
At tines both Moody’s and Standard & Poor’s have used adjustments to these ratings. Standard &
Poor’s uses plus and minus signs; A+ is the strongest. A rating and A- the weakest, Moody’s uses a
1,2, or 3 designation--- with 1 indicating the strongest.
Bond Ratings
Very High Quality
Moody’s
Aaa
Aa
S&P
AAA
AA
Rating’s Meaning
Capacity to pay interest
Principal is extremely strong
High Quality
A
BBa
A
BBB
Rating A has a strong capacity to pay
interest and repay principal
Rating Baa and BBB have an adequate
capacity to pay interest and repay
principal
The changes are affected by economic
conditions
Speculative
(Junk Bonds)
Ba
B
BB
B
Respect to capacity to pay interest and
repay principal in accordance with the
terms of the obligation
Rating BB and Ba indicate the lowest
degree of speculation
Very Poor
Caa
Ca
C
D
CCC
CC
C
D
Rating CC and Ca indicate the highest
degree of speculation
These are outweighed by large
uncertainties or major risk exposures to
adverse conditions
Rating C indicate reserving for income
bonds on which no interest is being paid
Rating D is in default and payment of
interest and/ or repayment of principal
is in arrears
Big Player in the market -- Moody’s
Moody’s Investors Service is among the world’s most respected, widely utilized sources for credit
ratings, research and risk analysis.
Moody’s ratings coverage:
Corporate Finance
Moody's rating coverage in the corporate sector has about 4,000 companies and more than US$2.5
trillion of outstanding debt. Areas covered are:
-Investment Grade
-Leveraged Finance
-Syndicated Loans
-Project Finance
Banking
Moody's maintains credit risk and financial strength ratings on over 1,000 individual banks in 80
countries.
Sovereign
Moody's provides sovereign ratings for more than 100 nations -- nearly every country that
participates in the world's capital markets.
Structured Finance
Moody's Structured Finance Group is the leading source of credit ratings and research for the
financial industry's most dynamic market. Structured Finance instruments covered by Moody’s:
-ABCP (Asset Backed Commercial Paper)
-ABS (Asset Backed Securities)
-MBS (Mortgage Backed Securities)
-Derivatives
US Public Finance
Moody’s maintain over 90,000 ratings for approximately 68,000 debt instruments on 22,500
municipal issuers, including the general obligations of governments, revenue bonds, and other
municipal instruments.