Notes On Credit Rating Agencies

Credit rating agencies take a wide range of factors – debt raising purpose, industry outlook, corporate profile and financial measures into account when performing corporate

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

Then, in the 1990s, bonds were created consisting of subprime mortgages, which were higher risk mortgages with high interest rates, made to borrowers with lower credit levels. Essentially, banks were handing out mortgages like candy to consumers who were never going to be able to make the payments, but Wall Street kept buying and packaging the mortgages into bonds. Since these bonds were inherently riskier, one wonders why investors were still willing to buy. Investors, who look at ratings by agencies such as Moodys and Standard & Poors, had no reason to believe these bonds were risky investments. The agencies, whom were being paid by Wall Street, were assigning high ratings to these risky bonds.

Credit rating agencies take a wide range of factors – debt raising purpose, industry outlook, corporate profile and financial measures into account when performing corporate bond

Beside internal factors, we examine the external factors, Opportunities and Threats, of KBRA. The incumbent credit raters’ fail in the financial crisis gave an opportunity for new rating agencies like KBRA. After the financial crisis, the government and the investors realized the importance of appropriate corporate credit rating. The government might tend to subsidize newly-established rating organizations and create new regulations for credit rating in order to eliminate the oligopoly of three big financial agencies. KBRA benefits from such environment. Also, it is easier for small or new rating agencies like KBRA to apply a new revenue model under revised regulations.

Rating agencies also had a strong motivation to compete for market share by catering to their clients. In 2000, Moody’s became an independent, publicly owned firm after being released by its parent company, Dun & Bradstreet. This placed even more pressure on Moody’s managers to increase revenues and improve their shareholder’s returns. (Lawrence, p. 456) From this point on, we begin to see the credit rating agencies drastically underestimate the risks of mortgage-backed securities in a selfish attempt to further their own bottom lines. The birth of structured finance came from new techniques of quantitative analysis used by Wall Street investment banks, and suddenly, Moody’s was not just evaluating corporate, municipal, state and federal government bonds. Structured finance consisted of combining income-producing assets—everything from conventional corporate bonds to credit card debt, home mortgages, franchise payments, and auto loans—into pools and selling shares in the pool to investors. (Lawrence, p. 456)

So it is also attractive for Jules Kroll to take this opportunity to enter the credit rating industry. In addition, the “issuer pays” model, which used by the big three rating agencies, lets companies shop around for the best ratings, putting pressure on the agencies to inflate their grades. As a result, it is very difficult to argue that they can adequately represent the users’ side. Therefore, Jules Kroll wants to use another model that can assign unbiased and reliable ratings.

b) The ratings methodologies employed by these various bond rating agencies are a mixture of financial performance, information and subjective objectives and management quality information. All of this information is synthesized for the purpose of using it to predict the creditworthiness of the bond issuer, which is inversely related to the risk of default. Based on the above bond rating methodology,

Lending evaluations by Santander are based on credit background of the person (or company) who wants borrow. Through the development of a credit-approval system, Santander Consumer Finance increased an understanding into these clients on an online database which allowed for the use of real time analysis in determining interest rates for the business interactions.

In the capital markets, lower bond ratings would result in a higher cost of debt, and actually may negatively impact the stock price, as investors might pay less for a riskier asset to generate a higher required return.

It should be noted, prior to the crisis, there was already an increasing concern of economists and critics about the credit quality that was provided by the financial sector at the time when there was low interest rates that were applied by the government. There were also issues about the inappropriateness or ineffectiveness of the standards that were used in extending credit by the financial sector (Calvo, 171).

From the perspective of the most recent S&P Bond Guide, due to the financial problem in 1994, three-level downgrading was applied to the B Bond yield rate that results in the rating position change in industry average yield into BB by 8.8%. Therefore, the different BB yield and the industry average rate indicated that the investor required a higher return on B bond since it is more risky than that in the previous year. There is a restriction in decision making of buying the B bonds in this

There are many types of rating that can be granted to a company after evaluate the company assets and liabilities. The best rating is AAA1 which has a superior capacity to meet its financial obligations while the lowest rating is D which currently in default on either all or a substantial portion of its financial obligation. Dutch Lady Milk Industries Berhad had been granted a credit rating of AAA1 with an interest charge of 2.50 % in 2014. This rating was not showing in the RAM but based on the information obtained in the annual report 2014. In addition, the higher the rate obtained, the lower the interest charge. Therefore, a good credit rating shows that Dutch Lady Milk Industries Berhad has higher

As technology improves, the wide use of “hard information”, such as the borrower’s credit history, reduces informational asymmetries. Therefore, long-distance small business lending is easier (Frame, Srinivasan, \& Woosley, 2001; Petersen \& Rajan, 2002). However, even with the use of credit score data, collecting ``soft information" still helps local lenders control risks to avoid delinquency (DeYoung, Glennon, \& Nigro, 2008) and provides informational advances in offering more favorable rates (Agarwal \& Hauswald, 2010).

Another financial vehicle that could be problematic was CDS (credit default swap). CDS is a financial derivative works like insurance on securities. The underwriter is obligated to pay a pre-determined fee to counterparty if a certain security default. In return, underwriters charge a fee as compensation. CDS can be used to hedge against risks. However there are still some difference between a CDS and an insurance contract.