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Definition: A credit ratings agency is a company that assigns credit ratings to institutions that issue debt obligations (i.e. assets backed by receivables on loans, such as mortgage-backed securities. These institutions can be companies, cities, non-profit organizations, or national governments, and the securities they issue can be traded on a secondary market.

A credit rating measures credit worthiness, or the ability to pay back a loan. It affects the interest rate applied to loans - interest rates vary depending on the risk of the investment. A low-rated security has a high interest rate, in order to attract buyers to this high-risk investment. Conversely, a highly-rated security (carrying a AAA rating, like a municipal bond which is backed by stable government agencies) has a lower interest rate, because it is a low-risk investment. These low-risk bonds are available to a wide range of investors, whereas high-risk bonds cater to a narrow investing demographic.

Companies that issue credit scores for individuals are usually called credit bureaus and are distinct from corporate ratings agencies.

Big Three

The top three credit ratings agencies in the United States are:

• Moody's
• Standard & Poor's
• Fitch Ratings

In the wake of recent credit-market turmoil, some niche agencies are picking up market share or at least additional visibility. Among the niche agencies are DBRS and Egan-Jones.

Rating Grades

Each rating agency has developed its own system of rating grades for sovereign and corporate borrowers. Fitch Ratings developed a rating grade system in 1924 that was adopted by Standard & Poor's. Moody's grading is slightly different. Moody's sometimes argues that their ratings embed a conceptually superior approach that directly considers not only the likelihood of default but also the severity of loss in the event of default.

Long Term Credit Rankings?

Fitch Ratings and Standard & Poor's use a system of letter sliding from the best rating "AAA" to "D" for issuers already defaulting on payments.

• Investment Grade
  • AAA  : best quality borrowers, reliable and stable without a foreseeable risk to future payments of interest and principal
  • AA  : very strong borrowers; a bit higher risk than AAA
  • A  : upper medium grade; economic situation can affect finance
  • BBB  : medium grade borrowers, which are satisfactory at the moment

• Non-Investment Grade
  • BB  : lower medium grade borrowers, more prone to changes in the economy, somewhat speculative
  • B  : low grade, financial situation varies noticeably, speculative
  • CCC  : poor quality, currently vulnerable and may default
  • CC  : highly vulnerable, most speculative bonds
  • C  : highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations
  • CI  : past due on interest
  • R  : under regulatory supervision due to its financial situation
  • SD  : has selectively defaulted on some obligations
  • D  : has defaulted on obligations and S&P believes that it will generally default on most or all obligations
  • NR  : not rated

Moody's grading follows a different system

• Investment Grade
  • Aaa: Obligations rated Aaa are judged to be of the highest quality, with the "smallest degree of risk"
  • Aa1, Aa2, Aa3: Obligations rated Aa are judged to be of high quality and are subject to very low credit risk, but "their susceptibility to long-term risks appears somewhat greater".
  • A1, A2, A3: Obligations rated A are considered upper-medium grade and are subject to low credit risk, but that have elements "present that suggest a susceptibility to impairment over the long term".
  • Baa1, Baa2, Baa3: Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such "protective elements may be lacking or may be characteristically unreliable".

• Non-Investment Grade
  • Ba1, Ba2, Ba3: Obligations rated Ba are judged to have "questionable credit quality."
  • B1, B2, B3: Obligations rated B are considered speculative and are subject to high credit risk, and have "generally poor credit quality."
  • Caa1, Caa2, Caa3: Obligations rated Caa are judged to be of poor standing and are subject to very high credit risk, and have "extremely poor credit quality. Such banks may be in default..."
  • Ca: Obligations rated Ca are highly speculative and are "usually in default on their deposit obligations".
  • C: Obligations rated C are the lowest rated class of bonds and are typically in default, and "potential recovery values are low".

• Others
  • WR: Withdrawn Rating
  • NR: Not Rated
  • P: Provisional

Which Companies Are Affected by Ratings?

Every company or country that has a rating will be affected in its borrowing costs, at least in public markets. A higher ranking means lower interest rates for the borrower and vice versa. The price of credit is set not only by relative credit ratings but also by the general supply of money and the specifics of an individual borrowing. A low-rated borrower, for example, can sometimes borrow more cheaply by securing the bond with a claim on specific assets, or by paying a third-party to insure the bond. Conversely, a highly-rated borrower may choose a structure that attracts a lower rating because of special characteristics of the issue, including its standing in the borrower's capital structure or the jurisdiction in which it is issued.

Recent developments

SInce the beginning of the credit crunch in early 2007 rating agencies have come under fire for their high ratings of mortgage backed securities (MBS) that did not reflect the financial stability of the borrowers. This has also reopened a discussion whether rating agencies, who get paid by borrowers for their rating, are not in a conflict of interest.