Profit & Solutions Management Research Publication Series
Researched & Written by Deb (Debadip) Bandyopadhyay
Moody’s credit rating looks at the probability of a debt instrument defaulting and the amount of loss this default will cause on the debt-holder. Moody’s credit ratings are expressed in terms of letters and numbers (United States, 2011). The characters range from AAA to C forming twenty-one categories. A rating of AAA means that the expected credit loss is at its lowest. A is the highest intrinsic financial strength.
Moody's Investors Service, often referred to as Moody's, is the bond credit rating business of Moody's Corporation, representing the company's traditional line of business and its historical name. Moody's Investors Service provides international financial research on bonds issued by commercial and government entities. Moody's, along with Standard & Poor's and Fitch Group, is considered one of the Big Three credit rating agencies. The company ranks the creditworthiness of borrowers using a standardized ratings scale which measures expected investor loss in the event of default. Moody's Investors Service rates debt securities in several bond market segments. These include government, municipal and corporate bonds; managed investments such as money market funds and fixed-income funds; financial institutions including banks and non-bank finance companies; and asset classes in structured finance. In Moody's Investors Service's ratings system, securities are assigned a rating from Aaa to C, with Aaa being the highest quality and C the lowest quality. Moody's was founded by John Moody in 1909 to produce manuals of statistics related to stocks and bonds and bond ratings. In 1975, the company was identified as a Nationally Recognized Statistical Rating Organization (NRSRO) by the U.S. Securities and Exchange Commission. Following several decades of ownership by Dun & Bradstreet, Moody's Investors Service became a separate company in 2000. Moody's Corporation was established as a holding company
Moody’s credit rating does not address the possibility of prepayment, particular securities being relatively valued, risk of liquidity, terms and the price during the investment process. Moody being the oldest rating agency in the world played a role in the subprime mortgage meltdown which made investors lose confidence in Moody. As a result of the subprime mortgage meltdown, initiatives that promote market transparency and rating of rating agencies have been implemented (United States et.al, 2011).
According to Moody's, the purpose of its ratings is to "provide investors with a simple system of gradation by which future relative creditworthiness of securities may be gauged". To each of its ratings from Aa through Caa, Moody's appends numerical modifiers 1, 2 and 3; the lower the number, the higher-end the rating. Aaa, Ca and C are not modified this way. As Moody's explains, its ratings are "not to be construed as recommendations", nor are they intended to be a sole basis for investment decisions. In addition, its ratings don't speak to market price, although market conditions may impact credit risk
Moody’s credit rating has its limitation. It only assesses the risk of credit loss which is important to investors when buying a security. However, a security is affected by other factors other than credit such as currency risk, interest rate risk and liquidity risk (Darbellay, 2013). If the Moody credit rating is used alone, it is a vague and incomplete substitution for the price of a security.
Part of the problem is ideological. At the most basic level, the combined income of all three sectors of an economy - the domestic private sector (including households and businesses), the government sector, and the foreign sector – must equal its expenditures. Sectors in the economy that are net issuing new financial liabilities are matched by sectors willingly owning new financial assets (Mattarocci, 2013). This is not only true of the income and expenditure sides of the equation, but also the financing side, which is rarely well integrated into macro analysis. But the neoliberals hate the idea of placing the government sector on par with the private and external sectors (Mattarocci, 2013). They view it as an unwanted appendage which adversely afflicts the operation of the private sector in a “free market” economy.
Moody’s credit rating relies on documentation of macroeconomic factors, scenarios and third parties. Moody should enhance transparency in relation to the assumptions they obtain from this documents. In conjunction with Moody’s credit rating, additional measurement tools should be developed that go beyond expected credit loss to include structured finance market pricing services and valuation (Deventer, 2013). This sets the groundwork for structured products by strengthening the secondary market (Great Britain, 2009).
There are measures instituted to protect the integrity of Moody’s credit rating as stipulated in their code of professional conduct (Lawrence &Weber, 2011). However, Moody should work at further enhancing the conflict of interest protections. There should be clear disclosure of rating agencies performance metrics, procedures and methodologies (Mattarocci, 2013).
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References
Darbellay, A. (2013). Regulating credit rating agencies. Cheltenham. Edward Elgar.
Deventer, D. R. (2013). Advanced financial risk management: Tools and techniques for integrated credit risk and interest rate risk management. Singapore: John Wiley & Sons.
Great Britain. (2009). Local authority investments: Report, together with formal minutes. London: TSO.
Lawrence, A.T., Weber, J. (2011). The Meaning of Corporate Social Responsibility. Business & society: stakeholders, ethics, public policy (13th Ed.) (pp. 50). New York: McGraw- Hill/Irwin
Mattarocci, G. (2013). The Independence of Credit Rating Agencies: How Business Models and Regulators Interact. Burlington: Elsevier Science.
United States, Levin, C., & Coburn, T. A. (2011). Wall Street and the financial crisis: Anatomy of a financial collapse. New York: Cosimo Reports.
United States. (2011). The financial crisis inquiry report: Final report of the National Commission on the Causes of the Financial and Economic Crisis in the United States. New York, NY: Public Affairs.