Credit rating agency is a private agency that grades investments for overall quality and degree of risk. These grades influence many investors’ decisions to buy, sell, or hold securities (stocks and bonds). Analysts assign ratings after periodically researching the companies and governments that issue the securities. They study such factors as financial affairs, management, and market performance. The agencies rate securities in descending order from best to worst, usually with a letter system from A to C or D. Rating agencies include Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s (S&P), all with headquarters in New York City.
Bond ratings are the most widely used kind of securities rating. When a bond falls due, the company or government that issued the bond is required to pay the investor the amount borrowed plus interest. Rating agencies issue bond ratings to represent the risk that a company or government will default (fail to pay) on this obligation. Rating agencies do not attempt to predict a bond’s potential for profit. Instead, they seek to inform investors about the relative risk of their investments.
Rating agencies also issue stock ratings. These ratings are based on a company’s past performance, including its earnings and dividends (payments to stockholders). In most cases, a stock with a history of growth and stability will receive a favorable stock rating. Unlike bond ratings, stock ratings can suggest a security’s potential for profit. However, high stock ratings do not necessarily indicate that strong economic patterns will continue in the future.
Rating agencies were more closely examined by governments and the press after a worldwide banking crisis that began in 2007. Securities that had been given high ratings by the agencies proved to be much riskier than expected when the United States housing market declined. This development called the ratings into question. In 2010, the U.S. Congress passed laws reforming the financial industry. One part of this legislation required much closer oversight of rating agencies by the Securities and Exchange Commission (SEC). The European Union adopted similar regulations after the banking crisis.
In 2016, Moody’s agreed to pay a record $130 million to settle a 2009 misconduct lawsuit filed by the largest U.S. pension fund over mortgage deals. The California Public Employees’ Retirement System, commonly known as Calpers, had accused Moody’s, S&P, and Fitch Ratings of making “negligent misrepresentations” when they awarded high grades to residential mortgage bonds that faltered during the collapse of the housing market in 2008. Calpers suffered losses on bonds it purchased based on the firms’ inflated ratings. The pension fund reached a $125 million settlement with S&P in 2015. S&P also agreed to a $1.5 billion civil settlement with the U.S. Department of Justice and a number of states over lawsuits stemming from the housing crisis. Fitch denied any wrongdoing in the Calpers lawsuit and settled in 2011 without any monetary payout.
See also Bond; Capital; Investment; Stock.
