What is Moody’s?
Moody’s is a large financial holding company that typically refers to Moody’s Investor Service and/or Moody’s Analytics. Along with Standard & Poor’s (S&P) and Fitch, Moody’s is one of the “big three” credit rating agencies and traces its roots to the early 1900s when its founder, John Moody, published its “Moody’s Manual of Industrial and Miscellaneous Securities.” Today, the company provides ratings of fixed-income securities that serve as an indicator of a company’s financial health and its ability to repay its debts as they come due. A change in credit rating can move bond prices as investors across markets pay close attention to Moody’s opinion on creditworthiness.
Key Learning Points
- Moody’s is one of the “big three” credit rating agencies, along with S&P and Fitch. As of 2022, Moody’s Investor Service covered more than 130 countries and over 11,000 corporate issuers.
- Moody’s operating model is similar to that of its two competitors (collectively the big three have over 95% market share) – it communicates its views on an issuer’s ability to satisfy its debt obligations on time, using a system of letters ranging from AAA to C.
- Sovereigns and corporates with a rating of BBB and above are referred to as Investment grade securities, while those rated Ba and below are non-investment grade or high yield (also known as junk bonds).
- Moody’s also provides complex analytical solutions for a wide range of clients through its Moody’s Analytics subsidiary. Some of their products include risk management, economic research, data, and regulatory reporting.
How Does Moody’s Work?
The model that Moody’s employs is similar to that of the other two big ratings institutions. It uses a unique system of letters to rate security and express a view on a bond’s credit risk, based on its default risk and overall financial health. Bonds are rated at the time of issuance and existing ratings are reviewed regularly as this would have an impact on the rate of interest at which the issuing company can borrow money.
There are certain factors that affect credit ratings, including the issuer’s previous history of borrowing and repaying debt, including any missed payments or defaults. However, those are all factors that rate creditworthiness based on past events. Rating agencies also look at the borrower’s current cash flows and debt levels, its ability to generate stable revenues and profit, and its financial outlook. While some of these assessments can be subjective, they also help to provide a forward-looking view on existing bond issues rather than relying purely on past information.
Example – please see the attached Ratings Action rationale from Moody’s.
The biggest criticism of the existing model is regarding potential conflicts of interest. Bond issuers pay credit rating agencies to be rated and therefore their independence is sometimes questioned since no organization would be happy with a lower rating. Consequently, professional investors typically conduct additional risk analysis to complement credit ratings.
What is a Moody’s Rating?
While the systems applied by the big three credit rating agencies may have some individual nuances, each assign a letter rating for an issuer’s long-term debt. For example, Moody’s ratings range from AAA at the high end of the spectrum (indicating the lowest risk) to C at the low end of the spectrum (highest risk).
Credit ratings scale across different agencies
There are further divisions in each letter rating and Moody’s adds a number between 1 and 3 to letter ratings. For example, a bond with a Baa2 rating is slightly more creditworthy than another with a rating of Baa3, but slightly less creditworthy than one rated Baa1.
Types of Bond Ratings
There are generally two types of bond credit ratings – investment grade and speculative (also known as high yield or junk).
This type of credit rating is extended to both sovereign and corporate borrowers that have a credit rating of BBB or higher. Such a rating is considered to convey a lower level of risk and the borrower is judged to be highly likely to meet all their payment obligations as they fall due. Due to their lower risk, the demand for investment grade bonds is high. Both governments and companies in this category can typically borrow money at favourable interest rates.
Bonds that are rated BB and below are higher risk and are often considered to be speculative. This indicates that such borrowers are more likely to default on their repayments or have done so in the past. Due to their higher-risk nature, non-investment grade bonds offer higher interest rates (also known as yield, hence the term “high yield bond”) to their holders.
What is Moody’s Analytics?
Moody’s Analytics is a leading provider of risk management solutions that are used by institutions and professional investors across various industries such as capital markets, insurance, and pension investment. The company, which is a subsidiary of Moody’s Corporation, specializes in financial intelligence and data analytics that support its clients in navigating different market conditions and making informed decisions. Some popular Moody’s Analytics tools include:
- Asset and Liability Management (ALM) – providing liquidity risk, pricing, and regulatory reporting solutions.
- Portfolio Management – data, research, credit, and multi-asset risk tools.
- Insurance and Investments – risk management, scenario-based financial modelling, and professional software.
- Credit Origination – end-to-end solutions that optimize the entire lending process.
- Global economic research – data, forecasts, and forward-looking analysis.
Credit rating agencies play an important role in the bond market by providing their views on specific issues and helping investors navigate different markets. A downgrade has the power to trigger the forced sale of a security, such as when a bond falls from investment grade to high yield. Institutional portfolio managers are often required to operate within a pre-defined credit quality environment. With a market share of over 30%, Moody’s remains one of the dominant players in this space.
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