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Encyclopedia > Credit rating agency
Corporate finance

Working capital management
Cash conversion cycle
Return on capital
Economic value added
Just In Time (business)
Economic order quantity
Discounts and allowances
Factoring (finance)
Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Image File history File links Download high resolution version (1031x740, 688 KB)Midtown Manhattan looking North from the Empire State Building, 2005. ... Corporate finance is a specific area of finance dealing with the financial decisions corporations make and the tools as well as analysis used to make these decisions. ... Cash conversion cycle or CCC, also known as the asset conversion cycle, net operating cycle, working capital cycle or just cash cycle, is used in the financial analysis of a business. ... Return on capital, also known as Return On Invested Capital (ROIC) is defined as NOPLAT / Invested Capital usually expressed as a percentage. ... Economic Value Added (EVA) is an estimate of true economic profit after making corrective adjustments to GAAP accounting, including deducting the opportunity cost of equity capital. ... Just In Time (JIT) is an inventory strategy implemented to improve the return on investment of a business by reducing in-process inventory and its associated costs. ... Economic Order Quantity (also known as the Wilson EOQ Model or simply the EOQ Model) is a model that defines the optimal quantity to order that minimizes total variable costs required to order and hold inventory. ... Discounts and allowances are modifications to the basic price. ... This article does not cite any references or sources. ...

Capital budgeting
Capital investment decisions
The investment decision
The financing decision
Capital investment decisions
The process of determining which potential long-term projects are worth undertaking, by comparing their expected discounted cash flows with their internal rates of return. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ...

Managerial finance
Financial accounting
Management accounting
Mergers and acquisitions
Balance sheet analysis
Business plan
Corporate action
Managerial Finance is that branch of finance that provide tools for a companys financial managers. ... The field of accounting that serves external decision makers, such as stockholders, suppliers, banks and government agencies See also: Management accounting field of accounting concerned with external users of a companys financial information. ... Management accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis in making informed business decisions that would allow them to be better equipped in their management and control functions. ... The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business... This article needs additional references or sources for verification. ... A business plan is a formal statement of a largely enforced business goal, the reasons why they are believed attainable, and the plan for reaching those goals (Fiifi Essel). ... A corporate action is an event taken by a public company that has a direct financial impact on of its shareholders. ...

Finance series
Financial market
Financial market participants
Corporate finance
Personal finance
Public finance
Banks and Banking
Financial regulation
This article does not cite any references or sources. ... This article does not cite any references or sources. ... There are two basic financial market participant catagories, Investor vs. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. ... Public finance (government finance) is the field of economics that deals with budgeting the revenues and expenditures of a public sector entity, usually government. ... “Banker” redirects here. ... Financial supervision is government supervision of financial institutions by regulators. ...

v d

A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations. In most cases, these issuers are companies, cities, non-profit organizations, or national governments issuing debt-like securities that can be traded on a secondary market. A credit rating measures credit worthiness, the ability to pay back a loan, and affects the interest rate applied to loans. (A company that issues credit scores for individual credit-worthiness is generally called a credit bureau or consumer credit reporting agency.) A credit rating assesses the credit worthiness of an individual, corporation, or even a country. ... The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering. ... Credit risk or credit worthiness is the risk of loss due to a counterparty defaulting on a contract, or more generally the risk of loss due to some credit event. Traditionally this applied to bonds where debt holders were concerned that the counterparty to whom theyve made a loan... A loan is a type of debt. ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... In the United States, a credit score is a numerical expression based on a statistical analysis of a persons credit files, to represent the creditworthiness of that person, which is the likelihood that the person will pay his or her debts. ... This article or section does not cite its references or sources. ... This article or section does not cite its references or sources. ...

Interest rates are not the same for everyone, but instead are based on risk-based pricing, a form of price discrimination based on the different expected costs of different borrowers, as set out in their credit rating. There exist more than 100 rating agencies worldwide. Risk-based pricing is the practice in the financial services industry to charge different interest rates on the same loan to different people, depending on their credit score and other factors which make it seem like they are more likely to not pay back the loan. ... Price discrimination exists when sales of identical goods or services are transacted at different prices from the same provider. ...


Credit rating agencies for corporations

For more information, see Bond credit rating. In investment, the credit rating assesses the credit worthiness of a corporation. ...

Agencies that assign credit ratings for corporations include:

  • UK Data Ltd (UK)

A.M. Best Company, Inc. ... Baycorp Advantage is the largest credit bureau in Australia and New Zealand. ... Dominion Bond Rating Service is a credit rating agency based in Toronto, Ontario. ... D&B redirects here. ... Fitch Ratings, Ltd. ... Moodys Corporation (NYSE: MCO) is the holding company for Moodys Investors Service which performs financial research and analysis on commercial and government entities. ... Publications Standard & Poors publishes a weekly (48 times a year) stock market analysis newsletter called The Outlook, which is issued both in print and online to subscribers. ...

Uses of ratings by credit rating agencies

Credit ratings are used by investors, issuers, investment banks, broker-dealers, and by governments. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both borrowers and lenders. This in turn increases the total supply of risk capital in the economy, leading to stronger growth. It also opens the capital markets to categories of borrower who might otherwise be shut out altogether: small governments, startup companies, hospitals and universities.

Ratings use by bond issuers

Issuers rely on credit ratings as an independent verification of their own credit-worthiness. In most cases, a significant bond issuance must have at least one rating from a respected CRA for the issuance to be successful (without such a rating, the issuance may be undersubscribed or the price offered by investors too low for the issuer's purposes). Recent studies by the Bond Market Association note that many institutional investors now prefer that a debt issuance have at least three ratings. Issuers also use credit ratings in certain structured finance transactions. For example, a company with a very high credit rating wishing to undertake a particularly risky research project could create a legally separate entity with certain assets that would own and conduct the research work. This "special purpose entity" would then assume all of the research risk and issue its own debt securities to finance the research. The SPE's credit rating likely would be very low and the issuer would have to pay a high rate of return on the bonds issued. However, this risk would not lower the parent company's overall credit rating because the SPE would be a legally separate entity. Conversely, a company with a low credit rating might be able to borrow on better terms if it were to form an SPE and transfer significant assets to that subsidiary and issue secured debt securities. That way, if the venture were to fail, the lenders would have recourse to the assets owned by the SPE. This would lower the interest rate the SPE would need to pay as part of the debt offering. The Bond Market Association is the international trade association for the bond market industry. ... A special purpose entity (SPE) (sometimes, especially in Europe, special purpose vehicle) is a body corporate (usually a limited company of some type or, sometimes, a limited partnership) created to fulfill narrow, specific or temporary objectives, primarily to isolate financial risk, usually bankruptcy but sometimes a specific taxation or regulatory... Secured debt is that category of debt in which a creditor has been granted a portion of the bundle of rights to specified property. ...

The same issuer also may have different credit ratings for different bonds. This difference results from the bond's structure, how it is secured, and the degree to which the bond is subordinated to other debt. Many larger CRAs offer "credit rating advisory services" that essentially advise an issuer on how to structure its bond offerings and SPEs so as to achieve a given credit rating for a certain debt tranche. This creates a potential conflict of interest, of course, as the CRA may feel obligated to provide the issuer with that given rating if the issuer followed its advice on structuring the offering. Some CRAs avoid this conflict by refusing to rate debt offerings for which its advisory services were sought. Secured debt is that category of debt in which a creditor has been granted a portion of the bundle of rights to specified property. ... A Subordinated bond is a bond that has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy. ... In structured finance, the word tranche (sometimes traunche) refers to one of several related securitized bonds offered as part of the same deal. ...

Ratings use by investment banks and broker-dealers

Investment banks and broker-dealers also use credit ratings in calculating their own risk portfolios (i.e., the collective risk of all of their investments). Larger banks and broker-dealers conduct their own risk calculations, but rely on CRA ratings as a "check" (and double-check or triple-check) against their own analyses. In finance, a portfolio is a collection of investments held by an institution or a private individual. ...

Ratings use by government regulators

Regulators use credit ratings as well, or permit these ratings to be used for regulatory purposes. For example, under the Basel II agreement of the Basel Committee on Banking Supervision, banking regulators can allow banks to use credit ratings from certain approved CRAs (called "ECAIs" or "External Credit Assessment Institutions") when calculating their net capital reserve requirements. In the United States, the Securities and Exchange Commission (SEC) permits investment banks and broker-dealers to use credit ratings from "Nationally Recognized Statistical Rating Organizations" (or "NRSROs") for similar purposes. The idea is that banks and other financial institutions should not need to keep in reserve the same amount of capital to protect the institution against (for example) a run on the bank, if the financial institution is heavily invested in highly liquid and very "safe" securities (such as U.S. government bonds or short-term commercial paper from very stable companies). The final version aims at: Ensuring that capital allocation is more risk sensitive; Separating operational risk from credit risk, and quantifying both; Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage. ... Basel Committee on Banking Supervision is an institution created by the central bank Governors of the Group of Ten nations (see G-10). ... ... The Securities and Exchange Commission, commonly referred to as the SEC, is the United States governing body which has primary responsibility for overseeing the regulation of the securities industry. ... Nationally Recognized Statistical Rating Organizations is a USA government designation that was created by SEC in 1975 to allow federal regulatory oversight of credit rating organizations. ... In the United States, the Securities and Exchange Commission (SEC) permits the use of credit ratings from certain credit rating agencies for certain regulatory purposes. ...

CRA ratings are also used for other regulatory purposes as well. The U.S. SEC, for example, permits certain bond issuers to use a shorten prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating from an NRSRO. Likewise, insurance regulators use credit ratings to ascertain the strength of the reserves held by insurance companies. A prospectus is a legal document that institutions and businesses use to describe what they have to offer for participants and buyers. ... This article is about short-term financing. ... The Federal Deposit Insurance Corporation (FDIC) was created by the Glass-Steagall Act of 1933. ...

It is important to note that under both Basel II and SEC regulations, not just any CRA's ratings can be used for regulatory purposes. (If this were the case, it would present an obvious moral hazard, since an issuer, insurance company, or investment bank would have a strong incentive to seek out a CRA with the most lax standards, with potentially dire consequences for overall financial stability.) Rather, there is a vetting process, of varying sorts. The Basel II guidelines (paragraph 91, et al), for example, describe certain criteria that bank regulators should look to when permitting the ratings from a particular CRA to be used. These include "objectivity," "independence," "transparency," and others. Banking regulators from a number of jurisdictions have since issued their own discussion papers on this subject, to further define how these terms will be used in practice. (See The Committee of European Banking Supervisors Discussion Paper, or the State Bank of Pakistan ECAI Criteria.)

In the United States, since 1975, NRSRO recognition has been granted through a "No Action Letter" sent by the SEC staff. Following this approach, if a CRA (or investment bank or broker-dealer) were interested in using the ratings from a particular CRA for regulatory purposes, the SEC staff would research the market to determine whether ratings from that particular CRA are widely used and considered "reliable and credible." If the SEC staff determines that this is the case, it sends a letter to the CRA indicating that if a regulated entity were to rely on the CRA's ratings, the SEC staff will not recommend enforcement action against that entity. These "No Action" letters are made public and can be relied upon by other regulated entities, not just the entity making the original request. The SEC has since sought to further define the criteria it uses when making this assessment, and in March 2005 published a proposed regulation to this effect.

On September 29, 2006, U.S. President George W. Bush signed into law the "Rating Reform Act of 2006". This law requires the U.S. Securities and Exchange Commission to clarify how NRSRO recognition is granted, eliminates the "No Action Letter" approach and makes NRSRO recognition a Commission (rather than SEC staff) decision, and requires NRSROs to register with, and be regulated by, the SEC. On Feb. 2, 2007, the SEC proposed a rule on "Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organizations" that would implement the CRA Reform Act.

Recognizing their role in capital formation, some governments have attempted to jumpstart their domestic rating-agency businesses with various kinds of regulatory relief or encouragement. This may, however, be counterproductive, if it dulls the market mechanism by which agencies compete, subsidizing less-capable agencies and penalizing agencies that devote resources to higher-quality opinions.

Ratings use in structured finance

Credit rating agencies may also play a key role in structured financial transactions. Unlike a "typical" loan or bond issuance, where a borrower offers to pay a certain return on a loan, structured financial transactions may be viewed as either a series of loans with different characteristics, or else a number of small loans of a similar type packaged together into a series of "buckets" (with the "buckets" or different loans called "tranches"). Credit ratings often determine the interest rate or price ascribed to a particular tranche, based on the quality of loans or quality of assets contained within that grouping. Structured finance describes any non-standard way of raising money. ... In structured finance, the word tranche (sometimes traunche) refers to one of several related securitized bonds offered as part of the same deal. ...

Companies involved in structured financing arrangements often consult with credit rating agencies to help them determine how to structure the individual tranches so that each receives a desired credit rating. For example, a firm may wish to borrow a large sum of money by issuing debt securities. However, the amount is so large that the return investors may demand on a single issuance would be prohibitive. Instead, it decides to issue three separate bonds, with three separate credit ratings -- A (medium low risk), BBB (medium risk), and BB (speculative) (using Standard & Poor's rating system). The firm expects that the effective interest rate it pays on the A-rated bonds will be much less than the rate it must pay on the BB-rated bonds, but that, overall, the amount it must pay for the total capital it raises will be less than it would pay if the entire amount were raised from a single bond offering. As this transaction is devised, the firm may consult with a credit rating agency to see how it must structure each tranche -- in other words, what types of assets must be used to secure the debt in each tranche -- in order for that tranche to receive the desired rating when it is issued. In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. ... Secured debt is that category of debt in which a creditor has been granted a portion of the bundle of rights to specified property. ...

Currently, there is some debate, particularly in France, about whether such consulting arrangements by credit rating agencies constitute a conflict of interest. Under this view, if a CRA has offered its consulting services in structuring such a financial arrangement (for which it charges a fee), that CRA may feel obligated to give each debt tranche the credit rating it suggested would result from their advice. Such criticism has intensified in the wake of large losses in the ABS collateralized debt obligation (ABS CDO) market that occurred despite being assigned top ratings by the CRAs. For instance, losses on $340.7 million worth of ABS collateralized debt obligations (ABS CDO) issued by Credit Suisse Group added up to about $125 million, despite being rated AAA or Aaa by Standard & Poor's, Moody's Investors Service and Fitch Group.[1] Collateralized debt obligations (CDOs) are a type of asset-backed security or structured finance product. ...

The rating agencies respond that their advice constitutes only a "point in time" analysis, that they make clear that they never promise or guarantee a certain rating to a tranche, and that they also make clear that any change in circumstance regarding the risk factors of a particular tranche will invalidate their analysis and result in a different credit rating. In addition, some CRAs do not rate bond issuances upon which they have offered such advice.


Credit rating agencies have been subject to the following criticisms:

  • Credit rating agencies do not downgrade companies promptly enough. For example, Enron's rating remained at investment grade four days before the company went bankrupt, despite the fact that credit rating agencies had been aware of the company's problems for months.[2][3] Some finance scholars[citation needed] have documented in empirical studies that yield spreads of corporate bonds start to expand as credit quality deteriorates but before a rating downgrade, implying that the market often leads a downgrade and questioning the informational value of credit ratings. This has led to suggestions that, rather than rely on CRA ratings in financial regulation, financial regulators should instead require banks, broker-dealers and insurance firms (among others) to use credit spreads when calculating the risk in their portfolio.
  • Large corporate rating agencies have been criticized for having too familiar a relationship with company management, possibly opening themselves to undue influence or the vulnerability of being misled.[citation needed] These agencies meet frequently in person with the management of many companies, and advise on actions the company should take to maintain a certain rating. Furthermore, because information about ratings changes from the larger CRAs can spread so quickly (by word of mouth, email, etc.), the larger CRAs charge debt issuers, rather than investors, for their ratings. This has led to accusations that these CRAs are plagued by conflicts of interest that might inhibit them from providing accurate and honest ratings. At the same time, more generally, the largest agencies (Moody's and Standard & Poor's) are often seen as agents of globalization and/or "Anglo-American" market forces, that drive companies to consider how a proposed activity might effect their credit rating, possibly at the expense of employees, the environment, or long-term research and development. These accusations are not entirely consistent: on one hand, the larger CRAs are accused of being too cosy with the companies they rate, and on the other hand they are accused of being too focused on a company's "bottom line" and unwilling to listen to a company's explanations for its actions.
  • The lowering of a credit score by a CRA can create a vicious cycle, as not only interest rates for that company would go up, but other contracts with financial institutions may be affected adversely, causing an increase in expenses and ensuing decrease in credit worthiness. In some cases, large loans to companies contain a clause that makes the loan due in full if the companies' credit rating is lowered beyond a certain point (usually a "speculative" or "junk bond" rating). The purpose of these "ratings triggers" is to ensure that the bank is able to lay claim to a weak company's assets before the company declares bankruptcy and a receiver is appointed to divide up the claims against the company. The effect of such ratings triggers, however, can be devastating: under a worst-case scenario, once the company's debt is downgraded by a CRA, the company's loans become due in full; since the troubled company likely is incapable of paying all of these loans in full at once, it is forced into bankruptcy (a so-called "death spiral"). These rating triggers were instrumental in the collapse of Enron. Since that time, major agencies have put extra effort into detecting these triggers and discouraging their use, and the U.S. Securities and Exchange Commission requires that public companies in the United States disclose their existence.
  • Agencies are sometimes accused of being oligopolists [4], because barriers to market entry are high and rating agency business is itself reputation-based (and the finance industry pays little attention to a rating that is not widely recognized). Of the large agencies, only Moody's is a separate, publicly held corporation that discloses its financial results without dilution by non-ratings businesses. The high profit on Moody's revenues (>50% gross margin), which are consistent with the high barriers to entry, do nothing to allay market fears of monopoly pricing.

As part of the Sarbanes-Oxley Act of 2002, Congress ordered the U.S. SEC to develop a report, titled Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Marketsdetailing how credit ratings are used in U.S. regulation and the policy issues this use raises. Partly as a result of this report, in June 2003, the SEC published a "concept release" called Rating Agencies and the Use of Credit Ratings under the Federal Securities Laws that sought public comment on many of the issues raised in its report. Public commentson this concept release have also been published on the SEC's website. In finance, a credit spread, or net credit spread, is the difference in yield between different securities due to different credit quality. ... In finance, a portfolio is a collection of investments held by an institution or a private individual. ... A KFC franchise in Kuwait. ... Presented by Todd Grisham This page is a candidate for speedy deletion. ... In many parts of economics there is an assumption that a complex system of determinants will tend to lead to a state of equilibrium. ... High yield debt (non-investment grade or junk bond) is a business term referring to a corporate debt instrument, usually a bond, that has a higher yield (compared to investment grade debt) because of a high perceived credit risk (default risk). ... Notice of closure stuck on the door of a computer store the day after its parent company, Granville Technology Group Ltd, declared bankruptcy (strictly, put into administration—see text) in the United Kingdom. ... The word receiver has a number of different meanings: In communications and information processing, a receiver is the recipient (observer) of a message (information), which is sent from a source (object). ... Death spiral financing occurs when a small company, in desperate need of money, takes an investors cash, but with a caveat. ... Enron Corporation (Former NYSE ticker symbol: ENE) was an American energy company based in Houston, Texas. ... Before the signing ceremony of the Sarbanes-Oxley Act, President George Bush meets with Senator Paul Sarbanes, Secretary of Labor Elaine Chao and other dignitaries in the Blue Room at the White House on July 30, 2002. ...

In December 2004, the International Organization of Securities Commissions (IOSCO) published a Code of Conduct for CRAs that, among other things, is designed to address the types of conflicts of interest that CRAs face. All of the major CRAs have agreed to sign on to this Code of Conduct and it has been praised by regulators ranging from the European Commission to the U.S. Securities and Exchange Commission. The International Organization of Securities Commissions (IOSCO) is an international organization that brings together the regulators of the world’s securities and futures markets. ...



  1. ^ Tomlinson, Richard & David Evans (2007-06-01), "CDOs mask huge subprime losses, abetted by credit rating agencies", International Herald Tribune
  2. ^ {{Citation | last = Borrus | first = Amy | author-link = | last2 = | first2 = | author2-link = | title = The Credit-Raters: How They Work and How They Might Work Better | newspaper = BusinessWeek | pages = | year = 2002 | date = 2002-04-08 | url = http://www.businessweek.com/magazine/content/02_14/b3777054.htm
  3. ^ Wyatt, Edward (2002-02-08), Credit Agencies Waited Months to Voice Doubt About Enron
  4. ^ "Measuring the measurers", The Economist, 2007-05-31

See also

This article or section does not cite its references or sources. ... Credit history or credit report is, in many countries, a record of an individuals or a companys past borrowing and repaying, including information about late payments and bankruptcy. ... This article does not cite any references or sources. ... Credit cards A credit card is a system of payment named after the small plastic card issued to users of the system. ... In the United States, a credit score is a numerical expression based on a statistical analysis of a persons credit files, to represent the creditworthiness of that person, which is the likelihood that the person will pay his or her debts. ... The Fair Credit Reporting Act (FCRA) is an American federal law (codified at 15 U.S.C. Â§ 1681 et seq. ... Identity taker is a term first appearing in U.S. literature in the 1990s, leading to the drafting of the Identity Theft and Assumption Deterrence Act. ...

External links

  • Klein, Alec. (2004) "Credit Raters Exert International Influence" Washington Post
  • Davies, Paul J. (2007) "How S&P put the triple A into CPDO" Financial Times



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