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Societal components Financial market participants and Banking This box: view · talk · edit A (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings. In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit , or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a ), and affects the interest rate applied to the particular security being issued. The value of such security ratings has been widely questioned after the 2007-09 financial crisis. In 2003 the U.S. Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest.[1] More recently, ratings downgrades during the European sovereign debt crisis of 2010-11 have drawn criticism from the EU and individual countries. A company that issues credit scores for individual credit-worthiness is generally called a credit bureau (US) or consumer credit reporting agency (UK). Contents [hide] • 1 Uses of ratings ○ 1.1 Ratings use by bond issuers ○ 1.2 Ratings use by government regulators ○ 1.3 Ratings use in • 2 Criticism ○ 2.1 Oligopoly produced by regulation • 3 List of credit rating agencies • 4 The Big Three • 5 CRA business models • 6 See also • 7 Further reading • 8 References • 9 External links [edit] Uses of ratings Credit ratings are used by investors, issuers, investment banks, broker-dealers, and governments. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering for both borrowers and lenders. This in turn increases the total supply of risk capital in the economy, leading to stronger growth. It also opens the capital markets to categories of borrower who might otherwise be shut out altogether: small governments, startup companies, hospitals, and universities. [edit] Ratings use by bond issuers Issuers rely on credit ratings as an independent verification of their own credit-worthiness and the resultant value of the instruments they issue. In most cases, a significant bond issuance must have at least one rating from a respected CRA for the issuance to be successful (without such a rating, the issuance may be undersubscribed or the price offered by investors too low for the issuer's purposes). Studies by the Bond Market Association note that many institutional investors now prefer that a debt issuance have at least three ratings. Issuers also use credit ratings in certain structured finance transactions. For example, a company with a very high credit rating wishing to undertake a particularly risky research project could create a legally separate entity with certain assets that would own and conduct the research work. This "special purpose entity" would then assume all of the research risk and issue its own debt securities to finance the research. The SPE's credit rating likely would be very low, and the issuer would have to pay a high rate of return on the bonds issued. However, this risk would not lower the parent company's overall credit rating because the SPE would be a legally separate entity. Conversely, a company with a low credit rating might be able to borrow on better terms if it were to form an SPE and transfer significant assets to that subsidiary and issue secured debt securities. That way, if the venture were to fail, the lenders would have recourse to the assets owned by the SPE. This would lower the interest rate the SPE would need to pay as part of the debt offering. The same issuer also may have different credit ratings for different bonds. This difference results from the bond's structure, how it is secured, and the degree to which the bond is subordinated to other debt. Many larger CRAs offer "credit rating advisory services" that essentially advise an issuer on how to structure its bond offerings and SPEs so as to achieve a given credit rating for a certain debt tranche. This creates a potential conflict of interest, of course, as the CRA may feel obligated to provide the issuer with that given rating if the issuer followed its advice on structuring the offering. Some CRAs avoid this conflict by refusing to rate debt offerings for which its advisory services were sought. [edit] Ratings use by government regulators Regulators use credit ratings as well, or permit ratings to be used for regulatory purposes. For example, under the Basel II agreement of the Basel Committee on Banking Supervision, banking regulators can allow banks to use credit ratings from certain approved CRAs (called "ECAIs", or "External Credit Assessment Institutions") when calculating their net capital reserve requirements. In the United States, the Securities and Exchange Commission (SEC) permits investment banks and broker-dealers to use credit ratings from "Nationally Recognized Statistical Rating Organizations" (NRSRO) for similar purposes. The idea is that banks and other financial institutions should not need keep in reserve the same amount of capital to protect the institution against (for example) a run on the , if the financial institution is heavily invested in highly liquid and very "safe" securities (such as U.S. government bonds or short-term commercial paper from very stable companies). CRA ratings are also used for other regulatory purposes as well. The US SEC, for example, permits certain bond issuers to use a shortened prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but without Federal Deposit Insurance Corporation insurance) comprise only securities with a very high NRSRO rating. Likewise, insurance regulators use credit ratings to ascertain the strength of the reserves held by insurance companies. In 2008, the US SEC voted unanimously to propose amendments to its rules[2] that would remove credit ratings as one of the conditions for companies seeking to use short-form registration when registering securities for public sale. This marks the first in a series of upcoming SEC proposals in accordance with Dodd-Frank to remove references to credit ratings contained within existing Commission rules and replace them with alternative criteria. Under both Basel II and SEC regulations, not just any CRA's ratings can be used for regulatory purposes. (If this were the case, it would present a moral hazard).[citation needed] Rather, there is a vetting process of varying sorts. The Basel II guidelines[3] (paragraph 91, et al.), for example, describe certain criteria that bank regulators should look to when permitting the ratings from a particular CRA to be used. These include "objectivity," "independence," "transparency," and others. Banking regulators from a number of jurisdictions have since issued their own discussion papers on this subject, to further define how these terms will be used in practice. (See The Committee of European Banking Supervisors Discussion Paper,[4] or the State Bank of Pakistan ECAI Criteria).[5] In the United States, since 1975, NRSRO recognition has been granted through a "No Action Letter" sent by the SEC staff. Following this approach, if a CRA (or investment bank or broker- dealer) were interested in using the ratings from a particular CRA for regulatory purposes, the SEC staff would research the market to determine whether ratings from that particular CRA are widely used and considered "reliable and credible." If the SEC staff determines that this is the case, it sends a letter to the CRA indicating that if a regulated entity were to rely on the CRA's ratings, the SEC staff will not recommend enforcement action against that entity. These "No Action" letters are made public and can be relied upon by other regulated entities, not just the entity making the original request. The SEC has since sought to further define the criteria it uses when making this assessment, and in March 2005 published a proposed regulation to this effect. On September 29, 2006, US President George W. Bush signed into law the "Credit Rating Reform Act of 2006".[6] This law requires the US Securities and Exchange Commission to clarify how NRSRO recognition is granted, eliminates the "No Action Letter" approach and makes NRSRO recognition a Commission (rather than SEC staff) decision, and requires NRSROs to register with, and be regulated by, the SEC. S & P protested the Act on the grounds that it is an unconstitutional violation of freedom of speech.[6] In the Summer of 2007 the SEC issued regulations implementing the act, requiring rating agencies to have policies to prevent misuse of nonpublic information, disclosure of conflicts of interest and prohibitions against "unfair practices".[7] Recognizing CRAs' role in capital formation, some governments have attempted to jump-start their domestic rating-agency with various kinds of regulatory relief or encouragement. This may, however, be counterproductive, if it dulls the market mechanism by which agencies compete, subsidizing less-capable agencies and penalizing agencies that devote resources to higher-quality opinions. [edit] Ratings use in structured finance Credit rating agencies may also play a key role in structured financial transactions. Unlike a "typical" loan or bond issuance, where a borrower offers to pay a certain return on a loan, structured financial transactions may be viewed as either a series of with different characteristics, or else a number of small loans of a similar type packaged together into a series of "buckets" (with the "buckets" or different loans called "tranches"). Credit ratings often determine the interest rate or price ascribed to a particular tranche, based on the quality of loans or quality of assets contained within that grouping. Companies involved in structured financing arrangements often consult with credit rating agencies to help them determine how to structure the individual tranches so that each receives a desired credit rating. For example, a firm may wish to borrow a large sum of money by issuing debt securities. However, the amount is so large that the return investors may demand on a single issuance would be prohibitive. Instead, it decides to issue three separate bonds, with three separate credit ratings—A (medium low risk), BBB (medium risk), and BB (speculative) (using Standard & Poor's rating system). The firm expects that the effective interest rate it pays on the A-rated bonds will be much less than the rate it must pay on the BB-rated bonds, but that, overall, the amount it must pay for the total capital it raises will be less than it would pay if the entire amount were raised from a single bond offering. As this transaction is devised, the firm may consult with a credit rating agency to see how it must structure each tranche—in other words, what types of assets must be used to secure the debt in each tranche—in order for that tranche to receive the desired rating when it is issued. There has been criticism in the wake of large losses in the collateralized debt obligation (CDO) market that occurred despite being assigned top ratings by the CRAs. For instance, losses on $340.7 million worth of CDOs issued by Credit Suisse Group added up to about $125 million, despite being rated AAA or Aaa by Standard & Poor's, Moody's Investors Service and Fitch Group.[8] The rating agencies respond that their advice constitutes only a "point in time" analysis, that they make clear that they never promise or guarantee a certain rating to a tranche, and that they also make clear that any change in circumstance regarding the risk factors of a particular tranche will invalidate their analysis and result in a different credit rating. In addition, some CRAs do not rate bond issuances upon which they have offered such advice. Complicating matters, particularly where structured finance transactions are concerned, the rating agencies state that their ratings are opinions (and as such, are protected free speech, granted to them by the "personhood" of corporations) regarding the likelihood that a given debt security will fail to be serviced over a given period of time, and not an opinion on the volatility of that security and certainly not the wisdom of investing in that security. In the past, most highly rated (AAA or Aaa) debt securities were characterized by low volatility and high liquidity—in other words, the price of a highly rated bond did not fluctuate greatly day-to-day, and sellers of such securities could easily find buyers. However, structured transactions that involve the bundling of hundreds or thousands of similar (and similarly rated) securities tend to concentrate similar risk in such a way that even a slight change on a chance of default can have an enormous effect on the price of the bundled security. This means that even though a rating agency could be correct in its opinion that the chance of default of a structured product is very low, even a slight change in the market's perception of the risk of that product can have a disproportionate effect on the product's market price, with the result that an ostensibly AAA or Aaa-rated security can collapse in price even without there being any default (or significant chance of default). This possibility raises significant regulatory issues because the use of ratings in securities and banking regulation (as noted above) assumes that high ratings correspond with low volatility and high liquidity. [edit] Criticism Credit rating agencies have been subject to the following criticisms: • Credit rating agencies do not downgrade companies promptly enough. For example, Enron's rating remained at investment grade four days before the company went bankrupt, despite fact that credit rating agencies had been aware of the company's problems for months.[9][10] Or, for example, Moody's gave Freddie Mac preferred stock the top rating until Warren Buffett talked about Freddie on CNBC and on the next day Moody's downgraded Freddie to one tick above junk bonds.[11] Some empirical studies have documented that yield spreads of corporate bonds start to expand as credit quality deteriorates but before a rating downgrade, implying that the market often leads a downgrade and questioning the informational value of credit ratings.[12] This has led to suggestions that, rather than rely on CRA ratings in financial regulation, financial regulators should instead require banks, broker-dealers and insurance firms (among others) to use credit spreads when calculating the risk in their portfolio. • Large corporate rating agencies have been criticized for having too familiar a relationship with company management, possibly opening themselves to undue influence or the vulnerability of being misled.[13] These agencies meet frequently in person with the management of many companies, and advise on actions the company should take to maintain a certain rating. Furthermore, because information about ratings changes from the larger CRAs can spread so quickly (by word of mouth, email, etc.), the larger CRAs charge debt issuers, rather than investors, for their ratings. This has led to accusations that these CRAs are plagued by conflicts of interest that might inhibit them from providing accurate and honest ratings. At the same time, more generally, the largest agencies (Moody's and Standard & Poor's) are often seen as promoting a narrow-minded focus on credit ratings, possibly at the expense of employees, the environment, or long-term research and development.[citation needed] These accusations are not entirely consistent: on one hand, the larger CRAs are accused of being too cozy with the companies they rate, and on the other hand they are accused of being too focused on a company's "bottom line" and unwilling to listen to a company's explanations for its actions.[citation needed]. • While often accused of being too close to company management of their existing clients, CRAs have also been accused of engaging in heavy-handed "blackmail" tactics in order to solicit business from new clients, and lowering ratings for those firms . For instance, Moody's published an "unsolicited" rating of Hannover Re, with a subsequent letter to the insurance firm indicating that "it looked forward to the day Hannover would be willing to pay". When Hannover management refused, Moody's continued to give Hannover Re ratings, which were downgraded over successive years, all while making payment requests that the insurer rebuffed. In 2004, Moody's cut Hannover's debt to junk status, and even though the insurer's other rating agencies gave it strong marks, shareholders were shocked by the downgrade and Hannover lost $175 million USD in market capitalization.[14] • The lowering of a credit score by a CRA can create a vicious cycle, as not only interest rates for that company would go up, but other contracts with financial institutions may be affected adversely, causing an increase in expenses and ensuing decrease in credit worthiness. In some cases, large loans to companies contain a clause that makes the loan due in full if the companies' credit rating is lowered beyond a certain point (usually a "speculative" or "junk bond" rating). The purpose of these "ratings triggers" is to ensure that the bank is able to lay claim to a weak company's assets before the company declares bankruptcy and a receiver is appointed to divide up the claims against the company. The effect of such ratings triggers, however, can be devastating: under a worst-case scenario, once the company's debt is downgraded by a CRA, the company's loans become due in full; since the troubled company likely is incapable of paying all of these loans in full at once, it is forced into bankruptcy (a so-called "death spiral"). These rating triggers were instrumental in the collapse of Enron. Since that time, major agencies have put extra effort into detecting these triggers and discouraging their use, and the U.S. Securities and Exchange Commission requires that public companies in the United States disclose their existence. • Agencies are sometimes accused of being oligopolists,[15] because barriers to market entry are high and rating agency business is itself reputation-based (and the finance industry pays little attention to a rating that is not widely recognized). Of the large agencies, only Moody's is a separate, publicly held corporation that discloses its financial results without dilution by non- ratings businesses, and its high profit margins (which at times have been greater than 50 percent of gross margin) can be construed as consistent with the type of returns one might expect in an industry which has high barriers to entry. • Credit Rating Agencies have made errors of judgment in rating structured products, particularly in assigning AAA ratings to structured debt, which in a large number of cases has subsequently been downgraded or defaulted. The actual method by which Moody's rates CDOs has also come under scrutiny. If default models are biased to include arbitrary default data and "Ratings Factors are biased low compared to the true level of expected defaults, the Moody’s [method] will not generate an appropriate level of average defaults in its default distribution process. As a result, the perceived default probability of rated tranches from a high yield CDO will be incorrectly biased downward, providing a false sense of confidence to rating agencies and investors."[16] Little has been done by rating agencies to address these shortcomings indicating a lack of incentive for quality ratings of credit in the modern CRA industry. This has led to problems for several banks whose capital requirements depend on the rating of the structured assets they hold, as well as large losses in the banking industry.[17] [18][19] AAA rated mortgage securities trading at only 80 cents on the dollar, implying a greater than 20% chance of default, and 8.9% of AAA rated structured CDOs are being considered for downgrade by Fitch, which expects most to downgrade to an average of BBB to BB-. These levels of reassessment are surprising for AAA rated bonds, which have the same rating class as US government bonds.[20][21] Most rating agencies do not draw a distinction between AAA on structured finance and AAA on corporate or government bonds (though their ratings releases typically describe the type of security being rated). Many banks, such as AIG, made the mistake of not holding enough capital in reserve in the event of downgrades to their CDO portfolio. The structure of the Basel II agreements meant that CDOs capital requirement rose 'exponentially'. This made CDO portfolios vulnerable to multiple downgrades, essentially precipitating a large margin call. For example under Basel II, a AAA rated securitization requires capital allocation of only 0.6%, a BBB requires 4.8%, a BB requires 34%, whilst a BB(-) securitization requires a 52% allocation. For a number of reasons (frequently having to do with inadequate staff expertise and the costs that programs entail), many institutional investors relied solely on the ratings agencies rather than conducting their own analysis of the risks these instruments posed. (As an example of the complexity involved in analyzing some CDOs, the Aquarius CDO structure has 51 issues behind the cash CDO component of the structure and another 129 issues that serve as reference entities for $1.4 billion in CDS contracts for a total of 180. In a sample of just 40 of these, they had on average 6500 loans at origination. Projecting that number to all 180 issues implies that the Aquarius CDO has exposure to about 1.2 million loans.) Pimco founder William Gross urged investors to ignore rating agency judgments, describing the agencies as "an idiot savant with a full command of the mathematics, but no idea of how to apply them."[22] • Ratings agencies, in particular Fitch, Moody's and Standard and Poors have been implicitly allowed by governments to fill a quasi-regulatory role, but because they are for-profit entities their incentives may be misaligned. Conflicts of interest often arise because the rating agencies, are paid by the companies issuing the securities — an arrangement that has come under fire as a disincentive for the agencies to be vigilant on behalf of investors. Many market participants no longer rely on the credit agencies ratings systems, even before the economic crisis of 2007-8, preferring instead to use credit spreads to benchmarks like Treasuries or an index. However, since the Federal Reserve requires that structured financial entities be rated by at least two of the three credit agencies, they have a continued obligation. • Many of the structured financial products that they were responsible for rating, consisted of lower quality 'BBB' rated loans, but were, when pooled together into CDOs, assigned an AAA rating. The strength of the CDO was not wholly dependent on the strength of the underlying loans, but in fact the structure assigned to the CDO in question. CDOs are usually paid out in a 'waterfall' style fashion, where income received gets paid out first to the highest tranches, with the remaining income flowing down to the lower quality tranches i.e.

There are no notable European CRAs, except for Fitch, 80% of which is owned by FIMALAC, a French firm and Capital Intelligence which is headquartered in Cyprus. [edit] The Big Three Main article: Big Three (credit rating agencies) The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and Fitch Ratings.[38] Moody's and S&P each control about 40 percent of the market. Third-ranked Fitch Ratings, which has about a 14 percent market share, sometimes is used as an alternative to one of the other majors.[39] [edit] CRA business models Most credit rating agencies follow one of two business models. Originally, all CRAs relied on a "subscriber-based" where the CRA would not distribute the ratings for free but would instead only provide the ratings to subscribers to the CRA's publications. Subscription fees would provide the bulk of the CRA's income. Today, most smaller CRAs still rely on this business model, which proponents believe allows the CRA to publish ratings that are less likely to be tinged by certain types of conflicts of interest. By contrast, most large and medium-sized CRAs (including Moody's, S&P, Fitch, Japan Credit Ratings, R&I, A.M. Best and others) today rely on an "issuer-pays" business model in which most of the CRA's comes from fees paid by the issuers themselves. Under this business model, while subscribers to the CRA's services are still provided with more detailed reports analyzing an issuer, these services are a minor source of income and most ratings are provided to the public for free. Proponents of this model argue that if the CRA relied only on subscriptions for income, the vast majority of bonds would go unrated since subscriber interest is low for all but the largest issuances. These proponents also argue that while they face a clear conflict of interest vis-a-vis the issuers they rate (as described above), the subscriber-based model also presents conflicts of interest, since a single subscriber may provide a large portion of a CRA's revenue and the CRA may feel obligated to publish ratings that support that subscriber's investment decisions. Credit rating A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by credit rating agency of the debt issuers likelihood of default.[1] Credit ratings are determined by credit ratings agencies. The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies analysts. Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government. The credit rating is used by individuals and entities that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations. Credit ratings are often confused with credit scores. Credit scores are the output of mathematical algorithms that assign numerical values to information in an individual's credit report. The credit report contains information regarding the financial history and current assets and liabilities of an individual. A bank or credit card company will use the credit score to estimate the probability that the individual will pay back loan or will pay back charges on a credit card. However, in recent years, credit scores have also been used to adjust insurance premiums, determine employment eligibility, as a factor considered in obtaining security clearances and establish the amount of a utility or leasing deposit. A poor credit rating indicates a credit rating agency's opinion that the company or government has a high risk of defaulting, based on the agency's analysis of the entity's history and analysis of long term economic prospects. A poor credit score indicates that in the past, other individuals with similar credit reports defaulted on loans at a high rate. The credit score does not take into account future prospects or changed circumstances. For example, if an individual received a credit score of 400 on Monday because he had a history of defaults, and then won the Powerball on Tuesday, his credit score would remain 400 on Tuesday because his credit report does not take into account his improved future prospects. Contents [hide] • 1 Credit scores ○ 1.1 North America ○ 1.2 Australasia (Australia and NZ) ○ 1.3 European Union • 2 Corporate credit ratings • 3 Sovereign credit ratings • 4 Short-term rating • 5 Credit bureaus and credit rating agencies • 6 See also • 7 References • 8 External links [edit] Credit scores Main article: Credit score An individual's credit score, along with his credit report, affects his or her ability to borrow money through financial institutions such as banks. The factors that may influence a person's credit score are:[2] • ability to pay a loan • interest • amount of credit used • saving patterns[not in citation given] • spending patterns • debt In different parts of the world different personal credit score systems exist. [edit] North America In the United States, an individual's credit history is compiled and maintained by companies called credit bureaus. Credit worthiness is usually determined through a statistical analysis of the available credit data. • A common form of this analysis is a 3-digit credit score. The most common form of credit score, know as the FICO credit score, however, the actual score is computed by credit bureaus. The term FICO is a registered trademark of Fair Isaac Corporation, which developed FICO and pioneered the credit rating concept in the late 1950s. In Canada, individuals receive credit ratings such as the North American Standard Account Ratings, also known as the "R" ratings, which have a range between R0 and R9. R0 refers to a new account; R1 refers to on-time payments; R9 refers to bad debt. [edit] Australasia (Australia and NZ) In Australia, The Australian Government Office of the Privacy Commissioner provides information on how to obtain a copy of your credit report. Personal credit reports in Australia are generally required to be given free of charge. There are two main credit reporting agencies, Veda Advantage and Dun & Bradstreet. People living in Tasmania can also contact "Tasmanian Collection Service". [edit] European Union

This section is empty. You can help by adding to it. [edit] Corporate credit ratings Main article: Bond credit rating The credit rating of a corporation is a financial indicator to potential investors of debt securities such as bonds. Credit rating is usually of a financial instrument such as a bond, rather than the whole corporation. These are assigned by credit rating agencies such as A. M. Best, Dun & Bradstreet, Standard & Poor's, Moody's or Fitch Ratings and have letter designations such as A, B, C. The Standard & Poor's rating scale is as follows, from excellent to poor: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D. Anything lower than a BBB- rating is considered a speculative or junk bond.[3] The Moody's rating system is similar in concept but the naming is a little different. It is as follows, from excellent to poor: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C. A. M. Best rates from excellent to poor in the following manner: A++, A+, A, A-, B++, B+, B, B-, C++, C+, C, C-, D, E, F, and S. The CTRISKS rating system is as follows: CT3A, CT2A, CT1A, CT3B, CT2B, CT1B, CT3C, CT2C and CT1C. All these CTRISKS grades are mapped to one-year probability of default. Moody's S&P Fitch Long-term Short-term Long-term Short-term Long-term Short-term Aaa AAA AAA Prime Aa1 AA+ AA+ A-1+ F1+ Aa2 AA AA High grade P-1 Aa3 AA- AA- A1 A+ A+ A-1 F1 A2 A A Upper medium grade A3 A- A- P-2 A-2 F2 Baa1 BBB+ BBB+ Baa2 BBB BBB Lower medium grade P-3 A-3 F3 Baa3 BBB- BBB- Ba1 BB+ BB+ Non-investment grade Ba2 BB BB speculative Ba3 BB- BB- B B B1 B+ B+ B2 B B Highly speculative B3 B- B- Caa1 CCC+ Substantial risks Not prime Caa2 CCC Extremely speculative Caa3 CCC- C CCC C In default with little CC Ca prospect for recovery C C DDD / D / DD / In default / D [edit] Sovereign credit ratings Further information: List of countries by credit rating

S&P's ratings of European countries (June 2011). AAA AA A BBB BB B CCC no rating A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad. It takes political risk into account.[4] Source: Euromoney Country risk June 2011 Country risk rankings (June 2011)[5][6] Least risky countries, Score out of 100 Previous Country Overall score Rank 1 1 Norway 92.44 2 6 Luxembourg 90.86 3 2 Switzerland 90.20 4 4 Denmark 89.07 5 3 Sweden 88.72 6 12 Singapore 87.65 7 5 Finland 87.31 8 7 Canada 87.24 9 8 Netherlands 86.97 10 13 Germany 85.73

The table shows the ten least-risky countries for investment as of June 2011. Ratings are further broken down into components including political risk, economic risk. Euromoney's bi-annual country risk index[7] monitors the political and economic stability of 185 sovereign countries. Results focus foremost on economics, specifically sovereign default risk and/or payment default risk for exporters (a.k.a. " credit" risk). A. M. Best defines "country risk"[8] as the risk that country-specific factors could adversely affect an insurer's ability to meet its financial obligations. [edit] Short-term rating A short-term rating is a probability factor of an individual going into default within a year. This is in contrast to long-term rating which is evaluated over a long timeframe. In the past institutional investors preferred to consider long-term ratings. Nowadays, short-term ratings are commonly used. First, the Basel II agreement requires banks to report their one-year probability if they applied internal-ratings-based approach for capital requirements. Second, many institutional investors can easily manage their credit/bond portfolios with derivatives on monthly or quarterly basis. Therefore, some rating agencies simply report short-term ratings. In Greater China, CTRISKS is the first CRA providing short-term ratings on sovereign risk, bank risk and corporations in the region. [edit] Credit bureaus and credit rating agencies Main articles: Credit bureau and Credit rating agency Credit scores for individuals are assigned by credit bureaus (US; UK: credit reference agencies). Credit ratings for corporations and sovereign debt are assigned by credit rating agencies. In the United States, the main credit bureaus are Experian, Equifax, and TransUnion. A relatively new credit bureau in the US is Innovis.[9] In the United Kingdom, the main credit reference agencies for individuals are Experian, Equifax, and Callcredit. There is no universal credit score as such, rather each individual lender credit scores based on its own wish-list of a perfect customer.[10] In Canada, the main credit bureaus for individuals are Equifax and TransUnion.[11][12] In India, commercial credit rating agencies include CRISIL, CARE, ICRA and Brickwork Ratings.[13] The credit bureaus for individuals in India are Credit Information Bureau (India) Limited (CIBIL) and Credit Registration Office (CRO). In Hong Kong, the locally-based credit rating agency is CTRISKS.[14] The firm offers sovereign ratings on major economies, bank ratings on banks in China, Taiwan, Hong Kong and Macau, obligor ratings on 4000 listed companies in Greater China, bonds ratings on 1000+ bonds in China, Taiwan and Hong Kong and product risk ratings on 1000+ investment products. The largest credit rating agencies (which tend to operate worldwide) are Dun & Bradstreet, Moody's, Standard & Poor's and Fitch Ratings.[citation needed] On July 14, 2010, Dagong Global Credit Rating Co. from China released a credit rating that is a break with other western credit rating agencies in an attempt to compete with them.[15] Information and Rating Agency Credo Line is the only Rating Agency in Ukraine which assigns short-term and long-term credit ratings to Ukrainian, CIS and Eastern-European importing companies in the course of their foreign economic activity and trade financing, in particular. What are credit rating companies and their impact on the economy At the outset, credit rating estimates the credit worthiness of either an individual, corporation, or even a country. The credit rating is usually a company, referred to as a credit rating agency which assigns the credit ratings for the issuers, which is a legal entity that develops, registers and sells securities for the purpose of financing its operations. This legal entity, as mentioned earlier can be an individual, corporation or a country which issues debt securities such as bonds in order to raise money. 1916: First credit ratings on corporate bonds and sovereign debt Credit rating plays an important role as it estimates if the subject (individual, corporation or a country) has the potential to pay back the loan. This can be a critical factor especially from a lender or investor’s perspective. As obvious, a poor credit rating indicates a high risk of the subject defaulting on the loan and vice versa. Credit ratings play an important role in setting the interest rates on the loan or money that is required to be raised. A sovereign credit ratings is the credit ratings of a sovereign enterprise, i. e. a new national government. The sovereign credit rating indicates the level of risk of the investing environment of a country and can be utilized by investors aiming to invest abroad. The sovereign credit rating also considers the political risk factor as well. Whenever a new business or federal government issuer engages a credit rating agency to supply a credit score on a future debt concern, the company generally assigns the rating towards the issuer, called a good Issuer Credit score (ICR), which displays an entity’s general capacity to satisfy its obligations prior to their conditions. The company then assigns ratings towards the issuer’s particular debt investments. Factors that influence credit ratings or a credit score Credit rating score is drawn upon the information from the subject’s credit report. While there are many various factors that play a role in the credit rating score, what’s important to notice is that the factors that impact one subject’s credit rating score can be entirely different to the factors that impact another subject’s credit rating score. This is due to the differences in the individual subject’s credit reports. Credit rating does not provide guidance on other aspects that are essential for investment decisions, aspects such as market liquidity or price volatility are ignored. This is why, for example, from a country’s perspective, bonds with the same rating may have different market prices. Credit rating agencies Of the many credit rating agencies, the ones that matter on a global scalre are: • Moody’s • Standard & Poor’s • Fitch Ratings • DBRS • Egan-Jones Credit Scores

Description Moody's S&P Fitch

Maximum Safety Aaa AAA AAA Description Moody's S&P Fitch

High Grade Aa1 AA+ AA+

High Grade Aa2 AA AA

High Grade Aa3 AA- AA-

Higher medium grade A1 A+ A+

Higher medium grade A2 A A

Higher medium grade A3 A- A-

Lower medium grade Baa1 BBB+ BBB+

Lower medium grade Baa2 BBB BBB

Lower medium grade Baa3 BBB- BBB-

Speculative Ba1 BB+ BB+

Speculative Ba2 BB BB

Speculative Ba3 BB- BB-

Highly Speculative B1 B+

Highly Speculative B2 B B

Highly Speculative B3 B-

Substiantially risky CCC+ CCC+

Substiantially risky Caa CCC CCC

Substiantially risky Ca CC CC

May be in default C C C

Extremely Speculative C C C

Role of credit ratings on countries Countries can issue government bonds denoted in the country’s currency in order to raise capital. Bonds can also be issued in foreign currency, referred to as soverign bonds. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain period of time, with an interest rate, to a country. Bonds are often referred to as risk free due to the fact that they are government owned and hence, governments can at any time raise taxes or create extra currency in order to redeem their bonds upon maturity. However, as we have seen recently, the issue of Greece counters this statement. Bonds are rated on various parameters such as: Economic Resiliency • the country’s economic strength, captured in particular by the GDP per capita – the single best indicator of economic robustness and, in turn, shock-absorption capacity. • institutional strength of the country, the key question being whether or not the quality of a country’s institutional framework and governance – such as the respect of property right, transparency, the efficiency and predictability of government action, the degree of consensus on the key goals of political action – is conducive to the respect of contracts. Combining these two indicators helps determine the degree of resiliency, and position the country in the rating scale: very high, high, moderate, low or very low. Financial Robustness • the financial strength of the government. The question is to determine what must be repaid (and how “tolerable” the debt is) and the ability of the government to mobilize resources: raise taxes, cut spending, sell assets, obtain foreign currency. • the susceptibility to event risk – that is the risk of a direct and immediate threat to debt repayment, and, for countries higher in the rating scale, the risk of a sudden multi-notch downgrade. The issue is to determine whether the debt situation may be (further) endangered by the occurrence of adverse economic, financial or political events. Combining these two indicators helps determine degrees of financial robustness and refine the positioning of the country on the rating scale. Determining the rating The determination of the exact rating is done on the basis of a peer comparison, and weighting additional factors that may not have been adequately captured earlier. Fitch Ratings developed a rating system in 1924 that was adopted by Standard & Poor’s Credit scores are aimed at reducing information asymmetries by giving information on all the rated security. Credit ratings also help answer some principal-agent trouble, such as capping how much risk an investor can take on the part of the principal. Besides, ratings can answer collective action trouble of dispersed arrears investors by helping the property to monitor performance, with downgrades serving in the form of signal to do this. Key facts about credit ratings • Credit ratings are only opinions about the relative credit risk of the subject • Credit ratings are not investment advice, or buy, hold, or sell recommendations. They are just one factor investors ‘might consider’ in making investment decisions • Credit ratings are not indications of the market liquidity of a debt security or its price in the secondary market. • Credit ratings are not guarantees of credit quality or of future credit risk Issues plaguaing the credit rating agencies Moody’s Corp and Standard and Poor’s triggered the worst financial crisis in decades when they were forced to downgrade the inflated ratings they slapped on complex mortgage-backed securities, a U.S. congressional report concluded. In one of the most stark condemnations of the credit rating agencies, a Senate investigations panel said the agencies continued to give top ratings to mortgage-backed securities months after the housing market started to collapse. And in more recent news, Moody’s came under sharp criticism from the European commission following the downgrading of Portugal’s debt status to junk. The commission claims that Moody’s are guilty of making assumptions that Portugal might need a second bail-out based on their credit rating