There are close to 120 private credit rating agencies in the world but Moody’s, Standard & Poor’s and Fitch control over 90% of ratings business.
Their business is to sell opinions based on quantitative (financial), qualitative (strategy of a company or stability of a country) and contextual data (current circumstances) data.
They work on a range of things but are primarily known for opinions on corporate debts and sovereign (country) debts; investors can use these opinions to assess ability of borrowers to repay debts.
Companies & countries borrow money, to run initiatives, by issuing bonds & are therefore called issuers.
When they borrow, issuers promise to pay principal and interest to the lender.
These ratings are considered important because they affect the ability of issuers to borrow and cost of their borrowing.
E.g. when ratings fall, investment in the bond is seen as riskier and for riskier investments, investors demand a higher interest rate.
Ratings agencies get paid for their opinions on companies but don’t make money for rating countries; they rate countries mostly for publicity.
For corporates, they can be paid by the issuer or by investors (subscribers), who are looking for information to invest.
The issuer-revenue-model is considered controversial because of conflict of interest i.e. if the issuer is paying to get rating, it can ask for a good rating to make borrowing cheaper.
Across 3 agencies, ratings are a spectrum with AAA (best i.e. issuer will most likely repay debt) on one end and D (worst i.e. a very high chance of default) on the other.
Between AAA & D, there are various grades such as AA+, AA, AA-, A+, … CCC-, CC, C etc.
Around the middle is BBB-, which is considered to be the cut-off for Investment Grading; Moody’s equivalent for this is Baa3 (the rating that Moody’s downgraded India to yesterday).
Anything below BBB- or Baa3 gets the issuer a ‘junk rating’ and most fund managers have a mandate to hold only investment grade bonds, so they start selling junk bonds, creating huge debt problems for the issuer.
