Regulatory Treatment Of Credit Rating Agencies
Today, credit rating agencies are free to develop and publish their credit rating opinions under strong First Amendment protections. Indeed, it is Standard & Poor’s key role as a publisher of credit ratings and financial information that has been the basis for judicial recognition of significant First Amendment protections afforded to Standard & Poor’s.
Given the vital role played by credit rating agencies in the securities markets, Standard & Poor’s recognizes that the Commission has a legitimate interest at this critical time for the U.S. securities markets in reviewing the conduct of credit rating agencies to ensure that the integrity of the credit rating process is not corrupted by conflicts of interest, abuse of confidential information or other dishonest or fraudulent conduct. Standard & Poor’s expects that upon completion of its current review, the Commission will find that the independence, objectivity and integrity that have been the hallmark of the U.S. credit rating industry have not been compromised and conclude that there is no compelling investor protection need to impose a new regulatory regime directly regulating credit rating agencies and the credit rating process.
Impact On The Eurozone Crisis
In Europe, the criticism has focused on sovereign debt rather than private mortgage securities. EU governments and ECB policymakers accused the Big Three of being overly aggressive in rating eurozone countries creditworthiness, exacerbating the financial crisis. They argue that the unduly negative evaluations accelerated the European sovereign debt crisis as it spread through Greece, Ireland, and Portugal, and Spainall of which received EU-IMF bailouts. S& Ps April 2010 decision to downgrade Greeces debt to junk status weakened investor confidence, raised the cost of borrowing, and made a financial rescue package in May 2010 all but inevitable.
The European Union again came under pressure in 2011 during the negotiations over Greeces second bailout, in which private creditors were persuaded to take a voluntary loss on their bonds in order to reduce Greeces overall debt. This schemeseen as necessary to restore Greeces financial healthwas complicated by S& Ps July 2011 announcement that it would consider such debt restructuring a selective default. Indeed, after what was considered the largest sovereign default in history, S& P lowered Greece to the second lowest rating. Despite fears of a deeper crisis, the restructuring went smoothly enough for S& P to raise Greeces sovereign credit rating back to B- by December 2012.
What Would Be The Impact On Australia
If there was a ratings downgrade you would probably expect to see some decline in the price of US government bonds so to the extent that Australian superannuation funds are holding those they will probably suffer a decline in the market value of those assets. Realistically, in terms of the long run stream of interest and principal repayments, it wouldnt have that much effect.
However, if investors worldwide decide to divest their holdings of government securities around the world, then Australian government bonds start to look attractive. The only problem there is not very many of them to go round.
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The Indisputable Role Of Credit Ratings Agencies In The 2008 Collapse And Why Nothing Has Changed
Standard & Poors office building on April 14, 2012 in New York, NY. Standard & Poors is one of the three major global rating agencies.
A scene from the Oscar-nominated movie The Big Short depicts the important role of credit ratings agencies during the Great Recession. It shows Melissa Leo as an employee of Standard & Poors explaining to Steve Carell why S& P continues to give AAA ratings to mortgage-backed securities . The answer given by her is: Theyll just go to Moodys.
The Role Of Credit Ratings Agencies In The Financial Crisis
Partnoy argues that the importance attached to credit ratings played a key role in the growth of the dysfunctional market for collateralised debt obligations . A CDO is created by setting up a special purpose entity that issues securities to investors in different tranches and uses the proceeds to purchase fixed-income securities. Investors are then paid off sequentially, depending on their tranche, so that those in lower tranches take losses before those in higher tranches. The volume of CDOs grew rapidly before the debt crisis. There were two reasons for this growth. The first was that banks wanted to get assets off their balance sheets to reduce their regulatory capital requirements. The second was arbitrage. Banks were able to create fixed-income structures where the combined worth of the tranches issued greatly exceeded the cost of the underlying assets. In synthetic CDOs no actual fixed-income securities were actually purchased. Instead the same credit exposure was attained by selling insurance on fixed-income securities using CDSs. Therefore the motivation appears to have been entirely arbitrage. But, how did those who structured these CDOs produce the magic of the whole being greater than the sum of the parts? In some CDOs the underlying securities were tranches of securities issued by other CDOs or even tranches backed by tranches backed by securities issued by other CDOs, making the transformation particularly hard to understand.
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List Of Top Credit Rating Agencies
The credit rating services provide lenders and borrowers with accurate information about the risks and opportunities associated with debt. Several agencies function internationally. With a combined market share of about 95%, Standard & Poors, Moodys Investors Service, and Fitch Ratings are the three most well-known international credit rating agencies. Here is how they work:
#1 Fitch Ratings
Fitch Ratings is an international credit rating agency established in 1923 and operating in New York and London, England. The company analyzes debts and the interest rate sensitivity they hold. It considers the politico-economic situations of a nation before assessing its sovereign debtSovereign DebtSovereign debt is the money borrowed by a countrys central government, primarily achieved by selling government bonds and securities. Treasury notes, bonds, and bills are some examples of sovereign debt issued by the United States.read more.
The agency uses a letter-based scoring system, with AAA, AA, A, and BBB representing investment grade and BB, B, CCC, CC, C, DDD, DD, and D showing non-investment class. For example, AAA rating denotes the high value of an entity or security, while D rating signifies a greater risk of defaulting on a loan. Many investors trust ratings provided by Fitch to distinguish investments that will not default and present significant returns.
#2 Moodys Investors Service
#3 Standard & Poors
Getting Help From The Professionals
The FCRA has certainly improved the dispute process. However, it can still take a lot of time and effort to get a negative item removed from your credit report. Thats because oftentimes, you need to work with the credit reporting agencies, your creditors, and debt collectors.
If you are too busy to spend your time writing dozens of letters to credit reporting agencies and creditors, there are legitimate credit repair services that can help you out.
They can also help you deal with your creditors and collection agencies. And since they have teams of lawyers with specific expertise and experience in this field, your chances of success are a lot higher.
Standard And Poor’s Investment Grade
|Highly vulnerable and default is a virtual certainty|
|SD or D||The borrower has already defaulted on one or more of their financial obligations|
With S& Ps ratings, market participants would likely prefer to buy bonds or loans ranked as AAA to BBB- outright because they have a higher chance that the borrower will not default on their loan obligations. Securities rated as BBB- can often have a more appealing return on an initial investment because of the slightly higher implied risk of default than other investment-rated securities.
These investments could be better suited to market participants with a higher appetite for risk or who prefer securities which might be slightly more volatile. If this is the case, it is important to have an effective risk management strategy in place before committing money to these sorts of loans, companies or bonds.
Bonds and other securities rated BB+ or below are known as high yield, because the risks are higher than investment grade securities, but so are the potential returns. This is why these ratings are known as speculative.
What Are Credit Rating Agencies
The main agencies on the market are Moody’s, Standard & Poor’sand Fitch Ratings. These three agencies alone hold about 85% of the market. There is virtually no competition in this market because the barriers to entry are very high.
The business model of rating agencies is based primarily on remuneration paid by the rated entities, advisory activities and the dissemination of rating data.
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What Is Credit Rating Agencies
A credit rating agency is a company which rates the debtors on the basis of their ability to pay back the debt in a timely manner. They rate large-scale borrowers, whether companies or governments.
A credit rating agency is an organization which assigns credit ratings to the debtors predicting their capability to pay back debt timely and simultaneously making the forecast on the chances of the debtor being default. These rating agencies rate large borrowers .
Some of the top credit agencies in the world are Moodys, Standard and Poors and Fitch Rating.
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Surveillance Process Adopted By Rating Agency
Rating agency believes it is of vital importance to monitor pool performance so that it is in line with the outstanding rating. Surveillance is necessary because the receivables from the pool of assets are used to service investors payouts. The investors recourse is thus limited to these receivable, and to credit enhancements, if any provided by the originator.
Additionally, complex structures have been introduced recent times in the securitization market, with issuances incorporating staggered payouts mechanisms, floating rate instruments and trigger based structures. These complexities require close monitoring by the trustee and the rating agency to ensures that the instruments adhere to the originally stipulated and appropriate action is initiated at the right time in case of any deviation.
Rating agency has set up a dedicated surveillance team to monitor the performance of rated pools. Transaction is monitored on a monthly basis and the key parameter is tracked. This is done on the basis of monthly servicer reports provided by servicer/trustees. The reports are checked for accuracy and performance analysed. Thereafter, the team interacts with the concerned parties to understand the reasons behind the trends, and the likely steps have been or need to be undertaken to arrest adverse fluctuations in the pools performance.
Key monitorables of rating agency surveillance process:
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Role Of Credit Rating Agencies In Securitization Process
- Analyzes individual assets in the pool, compares them to the historical performance of assets in its data bank, and subjects the pool to stress tests based on severe market conditions.
- Looks at the seasoning of the pool, as mortgages are more likely to default in the first four years.
- Evaluates geographic diversification of the loans.
- Projects the amount of credit enhancement needed based on the worst-case scenario.
- Secures legal certification that assets transferred to the SPV are true sale, and thus legally isolated from the reach of originator.
Ratings agencies and investors prefer a diversified pool of mortgages spread across the nation as opposed to one concentrated in a particular region, as regional recessions may jeopardize the performance of the pool. Furthermore, a larger pool provides benefits to both investors and the conduits, as the fixed cost of securitization is spread over a larger amount, thus providing economies of scale. The quality of the pool of the loans and geographic dispersion determines the quality of the underlying securities credit-enhanced by a third party. Private mortgage conduits are financial entities usually affiliated with major banks, insurance, and or manufacturing companies that buy residential or commercial loans and pool them into a portfolio from which asset backed securities are issued to investors in the capital market.
Use By Government Regulators
Regulatory authorities and legislative bodies in the United States and other jurisdictions rely on credit rating agencies’ assessments of a broad range of debt issuers, and thereby attach a regulatory function to their ratings. This regulatory role is a derivative function in that the agencies do not publish ratings for that purpose. Governing bodies at both the national and international level have woven credit ratings into minimum capital requirements for banks, allowable investment alternatives for many institutional investors, and similar restrictive regulations for insurance companies and other financial market participants.
The use of credit ratings by regulatory agencies is not a new phenomenon. In the 1930s, regulators in the United States used credit rating agency ratings to prohibit banks from investing in bonds that were deemed to be below investment grade. In the following decades, state regulators outlined a similar role for agency ratings in restricting insurance company investments. From 1975 to 2006, the U.S. Securities and Exchange Commission recognized the largest and most credible agencies as Nationally Recognized Statistical Rating Organizations, and relied on such agencies exclusively for distinguishing between grades of creditworthiness in various regulations under federal securities laws. The of 2006 created a voluntary registration system for CRAs that met a certain minimum criteria, and provided the SEC with broader oversight authority.
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Information Flow In The Credit Rating Process
. Standard & Poor’s rating analysis relies principally on the public information provided by the issuer, including audited financial and other information contained in the issuer’s annual, quarterly and current reports mandated by the U.S. federal securities laws and stock exchange and Nasdaq requirements, as well as press releases and other public disclosures published by the issuer. Meetings with corporate management are typically part of the credit rating process. The purpose of such meetings is to review the company’s key operating and financial plans, management policies and other credit factors that may have an impact on the credit rating issued.
In addition to information provided by the company, Standard & Poor’s makes extensive use of primary and third party databases as a source of additional information. Third party data providers are a source of timely financial information on the domestic insurance and banking industries, the corporate sector and the asset-backed and residential mortgage sectors. Other sources of information include the Federal Deposit Insurance Corporation, the National Association of Insurance Commisioners, the United States Census Bureau, the Institute for Real Estate Management and the Mortgage Bankers’ Association, among others.
Key Functions Of Credit Rating Agencies
Some of the key functions of credit rating agencies are discussed below:
- Low-cost information:- The credit rating agency collects, analyses, interprets and makes a proper conclusion of any complex data and transforms it into a very lucid and easily understandable manner.
- Provides a basis for suitable risk and return:- The instruments rated by rating agency gets greater confidence amongst investor community. It also gives an idea regarding the risk associated with the instrument.
- Helps in the formulation of Public policy:- If debt instruments are professionally rated, it becomes very easy to judge the eligibility of various securities for inclusion in the institutional portfolio with greater confidence.
- Provides superior information:- Credit rating agency being an independent rating agency, due to highly trained and professional staffs and with the access to information which is not publicly available information, these agencies are able to deliver superior information.
- Enhances corporate image:- Better credit rating for any credit investment enhances visibility and corporate image in the industry.
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Role Of Credit Rating Agencies In Capital Markets
The companies that assess the financial strength of companies and government entities, especially their ability to meet principal and interest payments on their debts are often referred to as a credit rating agency. The rating assigned to a given debt shows an agencys level of confidence that the borrower will honour its debt obligations as agreed. Credit rating agencies analyse the risk of default as compared to other issuers in the market. The creditworthiness of a financial system is rated by these agencies. The rating may help the investors to understand the correlation between risk and return of an instrument. Most of the investors analyse these rating to decide on their investment.
There are five credit rating agencies in India.
Usually, credit ratings follow a scale of AAA the highest rating to D . There are eight tiers AAA, AA, A, BBB, BB, B, C and D
Benefits of Credit Ratings to Investors
Help in decision-making Credit rating of an instrument can be used by the investors to know the risks associated with it. This helps the investors to select the instruments for their preference.
Regular reviews of ratings Credit rating agencies regularly review the ratings of financial systems. This is done to ensure that it is relevant to the existing condition of the issuer and market. So if an investor has purchased an instrument with the highest rating but finds it is going down, then he can decide to sell the instrument to curb the losses.
How Did Credit Reporting Agencies Get Started
The big three credit bureaus, TransUnion, Equifax, and Experian, all trace their ancestry to small, local investigative companies. These early credit bureaus would collect every bit of seemingly relevant information they could about a person, including employment history, marital status, age, race, religion, and testimonials.
They then provided this information to creditors, who used it to determine whether a person was worthy of a loan and how much interest they would be required to pay.
Over time, they grew and merged until the credit reporting system moved from one with many local bureaus to the current system of three major nationwide credit bureaus.
As this happened, the three largest bureaus became so powerful that it became necessary to regulate them. This resulted in the Fair Credit Reporting Act being passed to protect you from their growing power.
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