history of credit rating agencies

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A Brief History Of Credit Rating Agencies

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Posted: Aug 13, 2009 | Reprints

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Credit ratings provide individual and institutional investors with information that assists them indetermining whether issuers of debt obligations andfixed-income securities will be able to meettheir obligations with respect to those securities. Credit rating agencies provide investors withobjective analyses and independent assessments of companies and countries that issue suchsecurities. Globalization in the investment market, coupled with diversification in the types andquantities of securities issued, presents a challenge to institutional and individual investors whomust analyze risks associated with both foreign and domestic investments. Historical informationand discussion of three companies will facilitate a greater understanding of the function andevolution of credit rating agencies.

Fitch RatingsJohn KnowlesFitch founded the Fitch Publishing Company in 1913. Fitch published financialstatistics for use in the investment industry via "The Fitch Stock and Bond Manual" and "TheFitch Bond Book." In 1924, Fitch introduced the AAA through D rating system that has becomethe basis for ratings throughout the industry. With plans to become a full-service global ratingagency, in the late 1990s Fitch merged with IBCA of London, subsidiary of Fimalac, S.A., aFrench holding company. Fitch also acquired market competitors Thomson BankWatch and Duff& Phelps Credit Ratings Co. Beginning in 2004, Fitch began to develop operating subsidiaries
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specializing in enterprise risk management, data services and finance industry training with theacquisition of Canadian company, Algorithmics, and the creation of Fitch Solutions and FitchTraining. (For information bond ratings systems seeBond Ratings Agencies: Can You TrustThem.)

Moody's Investors ServiceJohn Moody and Company first published "Moody's Manual" in 1900. The manual publishedbasic statistics and general information about stocks and bonds of various industries. From 1903until the stock market crash of 1907, "Moody's Manual" was a national publication. In 1909Moody began publishing "Moody's Analyses of Railroad Investments", which added analyticalinformation about the value of securities. Expanding this idea led to the 1914 creation ofMoody's Investors Service, which, in the following 10 years, would provide ratings for nearly allof the government bond markets at the time. By the 1970s Moody's began rating commercialpaperand bank deposits, becoming the full-scale rating agency that it is today.

Standard & Poor'sHenry Varnum Poor first published the "History of Railroads and Canals in the United States" in

1860, the forerunner of securities analysis and reporting to be developed over the next century.Standard Statistics formed in 1906, which published corporate bond,sovereign debt andmunicipal bond ratings. Standard Statistics merged with Poor's Publishing in 1941 to formStandard and Poor's Corporation, which was acquired by The McGraw-Hill Companies, Inc. in1966. Standard and Poor's has become best known by indexes such as the S&P 500, a stockmarket index that is both a tool for investor analysis and decision making, and a U.S. economicindicator. (SeeA Trip through Index History to learn more about Standard & Poor's Indexes.)

Nationally Recognized Statistical Rating Organizations (NRSRO)Beginning in 1970, the credit ratings industry began to adopt some important changes andinnovations. Previously, investors subscribed to publications from each of the ratings agenciesand issuers paid no fees for performance of research and analyses that were a normal part ofdevelopment of published credit ratings. As an industry, credit ratings agencies began torecognize that objective credit ratings significantly increased in value to issuers in terms offacilitating market and capital access by increasing a securities issuer's value in the market place,and decreasing the costs of obtaining capital. Expansion and complexity in the capital marketscoupled with an increasing demand for statistical and analytical services led to the industry widedecision to charge issuers of securities fees for ratings services.

In 1975, financial institutions, such as commercial banks and securities broker-dealers, sought tosoften the capital and liquidity requirements passed down by the Securities and ExchangeCommission (SEC). As a result, nationally-recognized statistical ratings organizations (NRSRO)were created. Financial institutions could satisfy their capital requirements by investing in

securities that received favorable ratings by one or more of the NRSROs. This allowance is theresult of registration requirements coupled with greater regulation and oversight of the creditratings industry by the SEC. The increased demand for ratings services by investors andsecurities issuers combined with increased regulatory oversight has led to growth and expansionin the credit ratings industry.

An Overview of Credit RatingsCountries are issued sovereign credit ratings. This rating analyzes the general creditworthiness of
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a country or foreign government. Sovereign credit ratings take into account the overall economicconditions of a country including the volume of foreign, public and private investment, capitalmarket transparency and foreign currency reserves. Sovereign ratings also assess politicalconditions such as overall political stability and the level of economic stability a country willmaintain during times of political transition. Institutional investorsrely on sovereign ratings toqualify and quantify the general investment atmosphere of a particular country. The sovereignrating is often the prerequisite information institutional investors use to determine if they willfurther consider specific companies, industries and classes of securities issued in a specificcountry.

Credit ratings, debt ratings or bond ratings are issued to individual companies and to specificclasses of individual securities such aspreferred stock, corporate bonds and various classes ofgovernment bonds. Ratings can be assigned separately to short-term and long-term obligations.Long-term ratings analyze and assess a company's ability to meet it's responsibilities with respectto all of its securities issued. Short-term ratings focus on the specific securities' ability to performgiven the company's current financial condition and general industry performance conditions.(For more information see What Is A Corporate Credit Rating?)

ConclusionInvestors may utilize information from a single agency or from multiple rating agencies.Investors expect credit rating agencies to provide objective information based on soundanalytical methods and accurate statistical measurements. Investors also expect issuers ofsecurities to comply with rules and regulations set forth by governing bodies, in the same respectthat credit rating agencies comply with reporting procedures developed by securities industrygoverning agencies. Understanding the history and evolution of ratings agencies gives investorsinsight on the methodology that agencies use, as well as the quality of ratings from each agency.The analyses and assessments provided by various credit rating agencies provide investors withinformation and insight that facilitates their ability to examine and understand the risks andopportunities associated with various investment environments. With this insight, investors canmake informed decisions as to the countries, industries and classes of securities in which theychoose to invest.

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