Rating agencies, what they are and why they are important

Rating agencies play an important role in the global financial landscape, significantly influencing investment decisions and the functioning of markets.
We often hear news about a certain rating agency that has cut its outlook estimates or has revised the debt rating of a country or banking institution downwards.
These issues are now commonplace, but we don't always fully understand the extent of their impact and why these assessments are so crucial.
In this article, we will delve into what rating agencies are, what their ratings are for and why their judgments are so important for investment decisions.
Rating agencies, what are they and why are they important What are rating agencies? How do rating agencies work? Rating agencies: why are they important? What are the most famous rating agencies? What is the rating The types of ratings How the rating is issued The rating scales of the rating agencies The outlook from the rating agencies What are the rating agencies? Rating agencies are institutions specialized in evaluating the repayment capacity and reliability of financial issuers, such as companies or governments, and their financial instruments, such as bonds or stocks.
Their main objective is to provide an impartial and objective assessment of an entity's solvency, based on detailed financial analyzes and statistical models.
This assessment is based on detailed financial analyzes and statistical models, aiming to provide an objective and impartial judgment on the creditworthiness of the issuer or security in question.
The outcome of this evaluation is translated into the so-called "rating", an alphanumeric score that represents the issuer's ability to honor its commitments within the set times.
In practice, these agencies try to understand what the value of a government or bank bond is.
How do rating agencies work? Rating agencies operate through a rigorous and well-defined process.
To establish their rating, rating agency analysts collect the financial and operational data of a state or company, analyzing key indicators such as income, debt, cash flows and other relevant factors.
This information is then compared to the agency's established assessment criteria, which may vary depending on the industry or type of entity being assessed.
This evaluation in fact determines the "credit capacity" which is then classified on a standardized evaluation scale, i.e.
the rating.
Rating agencies: why are they important? The importance of rating agencies is intrinsic to the fact that they provide financial market participants with vital information for making informed investment decisions.
Investors, for example, use agency ratings to evaluate the risk associated with a potential investment.
The judgment of the rating agencies is so important also because, from their evaluation, the conditions of access to credit by the entities being evaluated follow.
This is why it is the same companies, or bodies, or states that make an explicit request for evaluation to the agencies on the market.
The rating determines the performance of the stock market and government bonds; Before buying a bond (which is like a credit, which the investor buys), any investor needs an accurate analysis of the economic, financial and asset stability conditions of the entity whose securities he is buying.
Rating agencies essentially aim to do this: analyze, study and evaluate the financial conditions of an entity and provide investors with a tool to weigh their investment choices and understand when an investment is safe.
What are the most famous rating agencies? There are three most well-known rating agencies, and they are all based in New York: Standard & Poor's Moody's Fitch These agencies enjoy a consolidated reputation in the financial sector and their ratings significantly influence international markets.
Moody's Corporation began operations around 1900, when John Moody and associates published “Moody's Manual of Industrial and Miscellaneous Securities,” which contained basic information on a wide range of securities.
Today, Moody's Investor Service not only provides information, but also reports research, risk analysis and credit ratings of more than 106,000 structured finance bonds.
Fitch Ratings was founded by John Knowls Fitch in 1913, when he used to publish statistical analyzes in his “The Fitch Stock and Bond Manual”.
In 1924, Fitch Publishing Company first introduced the AAA to D rating scale, which is still in use today.
Today, Fitch Ratings provides services from two offices in New York and London, as well as from its offices around the world.
Standard & Poor's was born in 1941 from the merger of Standard Statistics with Henry Varnum Poor, publisher of the “History of the Railroads and Canals of the United States”, one of the first attempts to identify the financial background of the US railways.
Today, S&P is not only known for its ratings releases, but is highly regarded for its market indices, such as the S&P 500 and the S&P Case-Shiller Home Price Index.
Other rating agencies such as DBRS and Egan-Jones have been trying to emerge since the beginning of the latest financial crisis but, so far, have failed to attract the attention of market participants.
What is rating Literally, in English rating means "evaluation".
Specifically, the rating is a judgment that expresses the reliability of a company, i.e.
its ability to repay a debt in a specific period of time.
The rating is a sort of "vote" that agencies give to a specific entity, which can be public or private.
Types of ratings Rating agencies offer different types of assessments depending on the entity being analysed.
Among the most common are credit ratings, which evaluate a company's financial solvency, and sovereign ratings, which evaluate a government's ability to meet its financial commitments.
How the rating is issued The rating issued by an agency is usually expressed through a combination of letters and symbols, or in some cases, through a numerical scale.
For example, a AAA rating represents the highest level of reliability, while a C rating or lower indicates a critical financial situation.
Securities that have a very low rating are also called "junk bonds", since they have no value whatsoever.
The rating scales of the rating agencies Each rating agency has its own rating scales, which indicate the quality of the rated credit.
However, there are some similarities between the scales of different agencies, allowing for a relative comparison between ratings issued by different entities.
RatingMeaning AAA Excellent quality of the institution, maximum stability and reliability AA Stable institution, but potentially exposed (it can do more, but does not commit itself) A Institution whose financial capacity is in adverse economic conditions BBB Institution whose finances are temporarily satisfactory B Entity with a variable economic situation CCC Entity with vulnerable finances CC Entity with highly vulnerable finances C Entity that has filed for bankruptcy RD The entity does not pay some commitments, but continues to pay other obligations D The entity is in bankruptcy therefore, it is insolvent The outlook from the rating agencies Another evaluation tool is the outlook which, in financial jargon, indicates the medium and long-term forecast for a company, in the rating evaluation that precedes it.
We often hear that the rating agency has "cut the bank's outlook", which means that the agency has cut the growth estimates of the analyzed company, since it does not expect an improvement for that stock.
There are three possible options for the outlook: positive, negative, stable.
It follows that: – if the outlook is positive, the future conditions of the company or country are expected to be better or equal to the present; – if the outlook is negative, worsening and further downgrading are foreseeable in the future; – if the outlook is stable, finally, no changes are expected, therefore, it is likely that the rating assessment will not change in the future.

Author: Hermes A.I.

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