What they are and why they are important
“There are two things you will never be without: one is your reputation and the other is your credit rating.” ~ Larry Winget
A credit rating is an analysis of the general creditworthiness of countries, companies and individuals – in other words, their ability to pay back their debts. International credit rating agencies are not new. They’ve been decades in the making and have developed a key role in evaluating the abilities of governments and companies to pay their debts. In short, they examine a debtor’s capability of making interest payments on time, and review any factors that may lead to debt not being paid on time.
Their role in the investment world
Acting as an independent entity, an international ratings agency will appraise the likelihood of expected and timeous returns from investments in governments, by evaluating a country’s ability to repay its loans.
- A government may garner loans by selling government bonds. When a purchaser is assured of return payment, with interest and by a set date, the interest would remain low. However, once there is danger of a downgrade – ie, meaning the country may struggle to buy back those bonds, the interest rate becomes higher in order to offset the investor’s risk. This means it becomes more expensive for the country in question to borrow money – a poor credit rating means a government will have to pay more for borrowed money.
- Governments use bonds to raise money for projects they need to undertake for their people. Investors buy these bonds on the expectation that when they are bought back by a country, this will be done at the agreed date and with an agreed interest rate. By buying back the bonds, the debt is repaid.
- A country’s ability to meet this commitment can be evaluated by looking at their track record in repaying previous debt, their current and future job market, the number of unemployed, the successful utilisation of resources, their support of business and the creation of viable infrastructure, management of state-owned enterprises, suppression and control of corruption, political factors and efficiency of government.
- Rating agencies objectively determine the overall strength and stability of governments and companies so that investors may choose the level of risk, and where they wish to hold that risk. Lower credit ratings mean greater risks for the lenders and higher costs for the borrowers. For instance, a downgrade for Britain would mean buyers of UK Government bonds would want to get paid more to compensate for the risk of holding the debt.
- Major investors such as pension funds study the analyses of sovereign (government) debt provided by international rating agencies to determine which countries are safe and which are more likely to default. Most countries have defaulted on their debt payments at some time in their history.
- When any country is downgraded, this will impact negatively on investments. There will be more assessment, more caution, and investors may prefer to put their money elsewhere rather than take the risk, even with a higher interest rate attached.
The ‘big 3’rating agencies
To evaluate the ability and willingness of any issuer – governments, financial institutions, corporations, insurance companies and structured finance – to meet financial obligations in full and on time, calls for integrity, expertise and a reputable track record in the agency itself. Whether this holds through history, over time and in times of crisis is debatable. Can they get ratings wrong? And the short answer is maybe – well – sometimes, yes.
However, these firms have spent decades evaluating the creditworthiness of nations and can be hugely influential. They also provide valuable financial data and information on bonds, equities and mutual funds.
Standard & Poor: Begun in 1860 by Henry Poor, who wrote a history of the finances of railroads and canals in the United States as a guide for investors. The “Standard” partner became attached when the Standard Statistics Bureau was set up to examine finances of non-railroad companies. The two businesses joined forces in the 1940s.
Moody: Begun in 1909 by John Moody. Moody published an analysis of the tangled and uncertain world of railway finances, grading the value of its stocks and bonds. Today, Moody’s Investors Service provides international financial research on bonds issued by commercial and government entities.
Fitch: John Fitch founded his publishing agency in 1914. It is a smaller version of the other two, covering a more limited share of the market than S&P and Moody’s, though it can be positioned as a ‘tie-breaker’ when the other two agencies have similar but not equal ratings.
The importance for developing countries
- Because the ratings agencies are themselves seen as a benchmark of integrity, they present a moral compass that serves as an incentive to developing countries to pursue more prudent and sensible monetary and fiscal policies.
- Favourable ratings are essential for governments and companies to successfully raise capital in international financial markets.
- Most investors who invest in institutions in both the developed and developing world, will consider rating agencies perspectives when making investment decisions.
- Whichever agency is canvassed, and despite using unique evaluation methods, they invariably present comparable conclusions.
Rating ourselves constantly on excellence and expertise
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Our commitment to fostering lasting relationships built on trust and personal service, has allowed us to create valuable partnerships with both individuals and businesses. Prescribing to the highest standards of ethics and integrity, we have developed the acumen and flexibility to successfully evolve with the changing financial needs of our clients.
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