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Moody's Investors Service
Company typeSubsidiary
IndustryBond credit ratings
PredecessorMoody's Analyses Publishing Company
Founded1909 (1909)
ParentMoody's Corporation
Websitewww.moodys.com/researchandratings

Moody's Investors Service, often referred to as Moody's, is the bond credit rating business of Moody's Corporation, representing the company's traditional line of business and its historical name. Moody's Investors Service provides international financial research on bonds issued by commercial and government entities and, with Standard & Poor's and Fitch Group, is considered one of the Big Three credit rating agencies.

The company ranks the creditworthiness of borrowers using a standardized ratings scale which measures expected investor loss in the event of default. Moody's Investors Service rates debt securities in several market segments related to public and commercial securities in the bond market. These include government, municipal and corporate bonds; managed investments such as money market funds, fixed-income funds and hedge funds; financial institutions including banks and non-bank finance companies; and asset classes in structured finance.[1] In Moody's Investors Service's ratings system securities are assigned a rating from Aaa to C, with Aaa being the highest quality and C the lowest quality.

Moody's was founded by John Moody in 1909 to produce manuals of statistics related to stocks and bonds and bond ratings. In 1975, the company was identified as a Nationally Recognized Statistical Rating Organization (NRSRO) by the U.S. Securities and Exchange Commission. Following several decades of ownership by Dun & Bradstreet, Moody's Investors Service became a separate company in 2000; Moody's Corporation was established as a holding company.

Role in capital markets

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Moody's Investors Service's closest competitors are Standard & Poor's (S&P) and Fitch Group. Together, they are sometimes referred to as the Big Three credit rating agencies. While credit rating agencies are sometimes viewed as interchangeable, Moody's, S&P and Fitch in fact rate bonds differently; for example, S&P and Fitch ratings measure the probability that a security will default, while Moody's ratings seek to measure the expected losses in the event of a default.[2] Although Fitch has a smaller percentage of the market, it is still much larger than other rating agencies. All three operate worldwide, maintaining offices on six continents, and rating tens of trillions of dollars in securities. However, only Moody's Corporation is a free-standing company.[3]

Moody's Investors Service and its close competitors play a key role in global capital markets as a supplementary credit analysis provider for banks and other financial institutions in assessing the credit risk of particular securities. This form of third party analysis is particularly useful for smaller and less sophisticated investors, as well as for all investors to use as an external comparison for their own judgments.[4]

Credit rating agencies also play an important role in the laws and regulations of the United States and several other countries, such as those of the European Union. In the United States their credit ratings are used in regulation by the U.S. Securities and Exchange Commission as Nationally Recognized Statistical Rating Organizations (NRSROs) for a variety of regulatory purposes.[3] Among the effects of regulatory use was to enable lower-rated companies to sell bond debt for the first time; their lower ratings merely distinguished them from higher-rated companies, rather than excluding them altogether, as had been the case.[5] However, another aspect of mechanical use of ratings by regulatory agencies has been to reinforce "pro-cyclical" and "cliff effects" of downgrades. In October 2010, the Financial Stability Board (FSB) created a set of "principles to reduce reliance" on credit ranges agencies in the laws, regulations and market practices of G-20 member countries.[4] Since the early 1990s, the SEC has also used NRSRO ratings in measuring the commercial paper held by money market funds.[3]

The SEC has designated seven other firms as NRSROs,[6] including, for example, A. M. Best, which focuses on obligations of insurance companies. Companies with which Moody's competes in specific areas include investment research company Morningstar, Inc. and publishers of financial information for investors such as Thomson Reuters and Bloomberg L.P.[7]

Especially since the early 2000s, Moody's frequently makes its analysts available to journalists, and issues regular public statements on credit conditions.[5] Moody's, like S&P, organizes public seminars to educate first-time securities issuers on the information it uses to analyze debt securities.[5]

Moody's credit ratings

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According to Moody's, the purpose of its ratings is to "provide investors with a simple system of gradation by which future relative creditworthiness of securities may be gauged". To each of its ratings from Aa through Caa, Moody's appends numerical modifiers 1, 2 and 3; the lower the number, the higher-end the rating. Aaa, Ca and C are not modified this way. As Moody's explains, its ratings are "not to be construed as recommendations", nor are they intended to be a sole basis for investment decisions. In addition, its ratings don’t speak to market price, although market conditions may impact credit risk.[8][9]

Moody's credit ratings
Investment grade
Rating Long-term ratings Short-term ratings
Aaa Rated as the highest quality and lowest credit risk. Prime-1
Best ability to repay short-term debt
Aa1 Rated as high quality and very low credit risk.
Aa2
Aa3
A1 Rated as upper-medium grade and low credit risk.
A2 Prime-1/Prime-2
Best ability or high ability to repay short term debt
A3
Baa1 Rated as medium grade, with some speculative elements and moderate credit risk. Prime-2
High ability to repay short term debt
Baa2 Prime-2/Prime-3
High ability or acceptable ability to repay short term debt
Baa3 Prime-3
Acceptable ability to repay short term debt
Speculative grade
Rating Long-term ratings Short-term ratings
Ba1 Judged to have speculative elements and a significant credit risk. Not Prime
Do not fall within any of the prime categories
Ba2
Ba3
B1 Judged as being speculative and a high credit risk.
B2
B3
Caa1 Rated as poor quality and very high credit risk.
Caa2
Caa3
Ca Judged to be highly speculative and with likelihood of being near or in default, but some possibility of recovering principal and interest.
C Rated as the lowest quality, usually in default and low likelihood of recovering principal or interest.

History of Moody's

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Founding and early history

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Moody's traces its history back to two publishing companies established by John Moody, the inventor of modern bond credit ratings. In 1900, Moody published his first market assessment, called Moody's Manual of Industrial and Miscellaneous Securities, and established John Moody & Company.[5] The publication provided detailed statistics relating to stocks and bonds of financial institutions, government agencies, manufacturing, mining, utilities, and food companies. It experienced early success, selling out its first print run in its first two months. By 1903, Moody's Manual was a nationally-recognized publication.[10]

The 1907 financial crisis fueled several changes in the markets, including the creation of the Federal Reserve System, and increased demand for market information unencumbered by financiers' conflict of interest—including independent analyses of bond creditworthiness.[5] While the Dutch had created a bond market as early as the 1600s, and Britain developed one in the centuries following, these bond markets tended to be small, and revolved around sovereign governments trusted to honor their debts. In the United States, the development of extensive railroad systems led to the development of corporate bond issues to finance them, and therefore a bond market several times larger than in other countries.[11] Closer to home, Moody was forced to sell his business, due to a shortage of capital.

Moody returned in 1909 with a new publication focused solely on railroad bonds, Analysis of Railroad Investments,[3][12] and a new company, Moody's Analyses Publishing Company.[5] While Moody acknowledged that the concept of bond ratings "was not entirely original" with him—he credited early bond rating efforts in Vienna and Berlin as inspiration—he was the first to publish them widely, in an accessible format.[13][5][11] Moody was also the first to charge subscription fees to investors.[12] In 1913 he expanded the manual's focus to include industrial firms and utilities; the new Moody's Manual offered ratings of public securities, indicated by a letter-rating system borrowed from mercantile credit-reporting firms. The following year, Moody incorporated the company as Moody's Investors Service.[10] Other rating companies followed over the next few years, including the antecedents of the "Big Three" credit rating agencies: Poor's in 1916, Standard Statistics Company in 1922,[5] and the Fitch Publishing Company in 1924.[3]

Moody’s expanded its focus to include ratings for U.S. state and local government bonds in 1919[11] and, by 1924, Moody's rated nearly the entire U.S. bond market.[10]

1930s to mid-century

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The relationship between the U.S. bond market and rating agencies developed further in the 1930s. As the market grew beyond that of traditional investment banking institutions, new investors again called for increased transparency, leading to the passage of new, mandatory disclosure laws for issuers, and the creation of the Securities and Exchange Commission (SEC).[11] In 1936 a new set of laws were introduced, prohibiting banks from investing in "speculative investment securities" ("junk bonds", in modern terminology) as determined by "recognized rating manuals". Banks were permitted only to hold "investment grade" bonds, following the judgment of Moody's, along with Standard, Poor's and Fitch. In the decades that followed, state insurance regulators approved similar requirements.[3]

In 1962, Moody's Investors Service was bought by Dun & Bradstreet, a firm engaged in the related field of credit reporting, although they continued to operate largely as independent companies.[11]

1970s to present

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In the late 1960s and 1970s, a significant development was the extension of ratings to commercial paper and bank deposits. Another was the introduction of issuer fees—a step taken by Moody's in 1970[5]—in which the major agencies began charging the issuers of bonds, as well as investors. Reasons for this change included a growing free rider problem related to the increasing availability of inexpensive photocopy machines,[14] and the increased complexity of the financial markets.[10][15] Rating agencies also grew in size as the number of issuers grew exponentially,[16] both in the United States and abroad, making the credit rating business significantly more profitable. In 2005 Moody's estimated that 90% of credit rating agency revenues came from issuer fees.[17]

The end of the Bretton Woods system in 1971 led to the liberalization of financial regulations, and the global expansion of capital markets in the 1970s and 1980s.[5] In 1975, the SEC changed its minimum capital requirements for broker-dealers, using bond ratings as a measurement. Moody's and nine other agencies (later five, due to consolidation) were identified by the SEC as "nationally recognized statistical ratings organizations" (NRSROs) for broker-dealers to use in meeting these requirements.[3][18]

The 1980s and beyond were a time of significant expansion for the global capital market and, as a result, for Moody's as well; it opened its first overseas offices in Japan in 1985, followed by offices in the United Kingdom in 1986, France in 1988, Germany in 1991, Hong Kong in 1994, India in 1998 and China in 2001.[5] The number of bonds rated by Moody's and the Big Three agencies grew substantially as well. As of 1997, Moody's was rating approximately $5 trillion in securities from 20,000 U.S. and 1,200 non-U.S. issuers.[12] The 1990s and 2000s were also a time of increased scrutiny, as Moody's was subject to lawsuits by unhappy issuers and investigation by the U.S. Department of Justice,[19] as well as criticism following the collapse of Enron, the U.S. subprime mortgage crisis and subsequent late-2000s financial crisis.[5][20]

Following several years of rumors and pressure from institutional shareholders,[21] in December 1999 Moody's parent Dun & Bradstreet announced it would spin off Moody's Investors Service into a separate publicly traded company. Although Moody's had fewer than 1,500 employees in its division, it represented approximately 51% of Dun & Bradstreet profits in the year prior to the announcement.[22] The spin-off was completed on September 30, 2000,[23] and, in the half decade that followed, the value of Moody's shares improved by more than 300%.[12]

Controversies

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Sovereign downgrades

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Moody's, along with the other major credit rating agencies, is often the subject of criticism from countries whose public debt is downgraded, generally claiming increased cost of borrowing as a result of the downgrade.[24] Examples of sovereign debt downgrades that attracted significant media attention at the time include Australia in the 1980s, Canada and Japan in the 1990s, Thailand during the 1997 Asian financial crisis,[5] and Portugal in 2011 following the European sovereign debt crisis.[25]

Unsolicited ratings

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Moody's has occasionally faced litigation from entities whose bonds it has rated on an unsolicited basis, and investigations concerning such unsolicited ratings. In October 1995, the school district of Jefferson County, Colorado sued Moody's, claiming the unsolicited assignment of a "negative outlook" to a 1993 bond issue was based on Jefferson County having selected S&P and Fitch to do its rating. Moody's rating raised the issuing cost to Jefferson County by $769,000.[26] Moody's argued that its assessment was "opinion" and therefore constitutionally protected; the court agreed, and the decision was upheld on appeal.[12]

In the mid-1990s, the U.S. Justice Department's antitrust division opened an investigation to determine whether unsolicited ratings amounted to an illegal exercise of market power,[19] however the investigation was closed with no antitrust charges filed. Moody's has pointed out that it has assigned unsolicited ratings since 1909, and that such ratings are the market's "best defense against rating shopping" by issuers. In November 1999, Moody's announced it would begin identifying which ratings were unsolicited as part of a general move toward greater transparency.[5] The agency faced a similar complaint in the mid-2000s from Hannover Re, a German insurer that lost $175 million in market value when its bonds were lowered to "junk" status.[27][28][3] In 2005, unsolicited ratings were at the center of a subpoena by the New York Attorney General's office under Eliot Spitzer, but again no charges were filed.[12]

Following the 2008 financial crisis, the SEC adopted new rules for the rating agency industry, including one to encourage unsolicited ratings. The intent of the rule is to counteract potential conflicts of interest in the issuer-pays model by ensuring a "broader range of views on the creditworthiness" of a security or instrument.[29][30]

Alleged conflicts of interest

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The "issuer pays" business model adopted in the 1970s by Moody's and other rating agencies has been criticized for creating a possible conflict of interest, supposing that rating agencies may artificially boost the rating of a given security in order to please the issuer.[3] The SEC recently acknowledged, however, in its September 30, 2011 summary report of its mandatory annual examination of NRSROs that the subscriber-pays model under which Moody’s operated prior to adopting the issuer pays model also "presents certain conflicts of interest inherent in the fact that subscribers, on whom the NRSRO relies, have an interest in ratings actions and could exert pressure on the NRSRO for certain outcomes".[31] Other alleged conflicts of interest, also the subject of a Department of Justice investigation the mid-1990s, raised the question of whether Moody's pressured issuers to use its consulting services upon threat of a lower bond rating.[32] Moody's has maintained that its reputation in the market is the balancing factor, and a 2003 study, covering 1997 to 2002, suggested that "reputation effects" outweighed conflicts of interest. Thomas McGuire, a former executive vice president, said in 1995 that: "[W]hat’s driving us is primarily the issue of preserving our track record. That’s our bread and butter".[33]

Late 2000s financial crisis

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The global financial crisis of the late 2000s brought increased scrutiny to credit rating agencies' assessments of complex structured finance securities. Moody's and its close competitors were subject to criticism following large downgrade actions beginning in July 2007.[34][35] Faced with having to put more capital against lower rated securities, investors such as banks, pension funds and insurance companies sought to sell their residential mortgage-backed securities (RMBS) and collateralized debt obligation (CDO) holdings.[36] The value of these securities held by financial firms declined, and the market for new subprime securitizations dried up.[37] Some academics and industry observers have argued that the rating agencies' mass downgrades were part of the "perfect storm" of events leading up to the financial crisis in 2008.[36][38][39][40]

In 2008, a study group established by the Committee on the Global Financial System (CGFS), a committee of the Bank for International Settlements, found that rating agencies had underestimated the severity of the subprime mortgage crisis, as had "many market participants". According to the CGFS, significant contributing factors included "limited historical data" and an underestimation of "originator risk" factors. The CGFS also found that agency ratings should "support, not replace, investor due diligence" and that agencies should provide "better information on the key risk factors" of structured finance ratings. In October 2007, Moody's further refined its criteria for originators, "with loss expectations increasing significantly from the highest to the lowest tier". In May 2008, Moody's proposed adding "volatility scores and loss sensitivities" to its existing rankings.[20][41] Although the rating agencies were criticized for "technical failings and inadequate resources", the FSB stated that the agencies' "need to repair their reputation was seen as a powerful force" for change.[4] Moody's has in fact lost market share in certain sectors due to its tightened rating standards on some asset-backed securities, for example the commercial mortgage-backed securities (CMBS) market in 2007.[42]

See also

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References

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  1. ^ "Market Segment". moodys.com. Moody's Investors Service. 2011. Retrieved 30 August 2011.
  2. ^ Felix Salmon (9 August 2011). "The difference between S&P and Moody's". Reuters.
  3. ^ a b c d e f g h i White, Lawrence J. (Spring 2010). "The Credit Rating Agencies". Journal of Economic Perspectives. 24 (2). American Economic Association: 211–226. doi:10.1257 (inactive 2023-08-02). Retrieved 30 August 2011. {{cite journal}}: Check |doi= value (help)CS1 maint: DOI inactive as of August 2023 (link)
  4. ^ a b c "Principles for Reducing Reliance on CRA Ratings" (PDF). financialstabilityboard.org. Financial Stability Board. 27 October 2010. Retrieved 30 August 2011.
  5. ^ a b c d e f g h i j k l m n Timothy J. Sinclair (2005). The New Masters of Capital: American Bond Rating Agencies and the Politics of Creditworthiness. Cornell University Press. Cite error: The named reference "Sinclair 05" was defined multiple times with different content (see the help page).
  6. ^ "Credit Rating Agencies - NRSROs". sec.gov. U.S. Securities and Exchange Commission. Retrieved 30 August 2011.
  7. ^ "Zacks Analyst Blog Highlights: Moody's Corp, Thomson-Reuters Corp., RiskMetrics Group Inc., Dun & Bradstreet Corp. and Interactive Data Corporation". zacks.com. 5 March 2010. Retrieved 30 August 2011.
  8. ^ "Ratings Definitions". moodys.com. Moody's Investors Service. 2011. Retrieved 30 August 2011.
  9. ^ "Report on the Activities of Credit Rating Agencies" (PDF). The Technical Committee of the International Organization of Securities Commissions. September 2003. Retrieved 1 December 2011.
  10. ^ a b c d "Moody's History: A Century of Market Leadership". moody's.com. Retrieved 17 August 2011.
  11. ^ a b c d e Richard Sylla (1–2 March 2000). A Historical Primer on the Business of Credit Ratings (PDF). The Role of Credit Reporting Systems in the International Economy. Washington, D.C.: The World Bank. Retrieved 30 August 2011.{{cite conference}}: CS1 maint: date format (link)
  12. ^ a b c d e f Yasuyuki, Fuchita (2006). Financial Gatekeepers: Can They Protect Investors?. Washington, D.C.: Brookings Institution Press. ISBN 978-0815729815. Retrieved 30 August 2011. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  13. ^ Richard S. Wilson (1987). Corporate Senior Securities: Analysis and Evaluation of Bonds, Convertibles, and Preferreds. Chicago: Probus.
  14. ^ White, Ben (31 January 2002). "Do Rating Agencies Make the Grade?; Enron Case Revives Some Old Issues". The Washington Post.
  15. ^ White, Lawrence J. (24 January 2009). "Agency Problems—And Their Solution". The American. American Enterprise Institute. Retrieved 1 December 2011.
  16. ^ Clarke, Thomas (2009). European corporate governance: readings and perspectives. Taylor & Francis. p. 15. ISBN 9780415405331. Retrieved 1 December 2011.
  17. ^ "Moody's Corporation Form 10-K Filing 2005" (PDF). files.shareholder.com. Moody's Corporation. 8 March 2005. Retrieved 30 August 2011.
  18. ^ "Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organization" (PDF). sec.gov. Securities and Exchange Commission. 2 February 2007. Retrieved 8 November 2011.
  19. ^ a b "Watching the Watchers: Justice Department Launches Probe of Moody's Ratings". Tulsa World. 28 March 1996.
  20. ^ a b "Ratings in structured finance: what went wrong and what can be done to address shortcomings?". CGFS Papers. 32. Committee on the Global Financial System. July 2008.
  21. ^ Lynn Sherman (16 December 1999). "Independent Moody's Could Be A More Vigorous Competitor". The Bond Buyer.
  22. ^ Kenneth N. Gilpin (16 December 1999). "Dun & Bradstreet Will Spin Off Moody's". The New York Times. Retrieved 30 August 2011.
  23. ^ Louise Bowman (November 2000). "Moody's blues". Airfinance Journal. Retrieved 30 August 2011.
  24. ^ Jason Raznick (8 July 2011). "How to Profit from European Threats Against Rating Agencies". Forbes.
  25. ^ Wolfgang Münchau (10 July 2011). "Don't blame Moody's for a messy euro crisis". The Financial Times.
  26. ^ Jefferson County School District No. R-1 v. Moody’s Investor’s Services, Inc., 175 F.3d 848 (1999).
  27. ^ Alec Klein (24 November 2004). "Credit Raters' Power Leads to Abuses, Some Borrowers Say". The Washington Post. Retrieved 30 August 2011.
  28. ^ Kevin D. Hall (18 October 2009). "How Moody's sold its ratings - and sold out investors". McClatchy. Retrieved 26 August 2011.
  29. ^ "Re-Proposed Amendments to Rule 17g–5" (PDF). Federal Register. U.S. Government Printing Office. 9 February 2009. Retrieved 6 December 2011.
  30. ^ "New Information-Posting Requirements for Issuers, Sponsors and Underwriters of Rated Structured Finance Securities". sidley.com. Sidley Austin LLP. 4 March 2010. Retrieved 6 December 2011.
  31. ^ "2011 Summary Report of Commission Staff's Examinations of Each Nationally Recognized Statistical Rating Organization" (PDF). sec.gov. Securities and Exchange Commission. 30 September 2011. Retrieved 17 October 2011.
  32. ^ "Moody's denies threatening firms with lower ratings". Miami Herald. 29 June 1996.
  33. ^ Becker, Bo; Milbourn, Todd (2011). "How did increased competition affect credit ratings?". Journal of Financial Economics. 101 (3): 493–514. doi:10.1016 (inactive 2023-08-02). Retrieved 30 August 2011. {{cite journal}}: Check |doi= value (help)CS1 maint: DOI inactive as of August 2023 (link)
  34. ^ The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (PDF). Washington, DC: U.S. Government Printing Office. January 2011. pp. xxv, 221–222, 226. ISBN 978-0-16-087727-8. Retrieved 3 November 2011.
  35. ^ Alec Klein (28 August 2011). "Ratings Firms Defend Assessment of Loan Securities". The Washington Post. Retrieved 3 November 2011.
  36. ^ a b United States Senate Permanent Subcommittee on Investigations (13 April 2011). "Wall Street and the Financial Crisis: Anatomy of a Financial Collapse" (PDF). Majority and Minority Staff Report. Committee on Homeland Security and Governmental Affairs. p. 6. Retrieved 8 November 2011.
  37. ^ United States Senate Permanent Subcommittee on Investigations (13 April 2011). "Wall Street and the Financial Crisis: Anatomy of a Financial Collapse" (PDF). Majority and Minority Staff Report. Committee on Homeland Security and Governmental Affairs. pp. 6, 57. Retrieved 8 November 2011.
  38. ^ Selig, Kevin. "Greed, Negligence or System Failure? Credit Rating Agencies and the Financial Crisis" (PDF). The Kenan Institute for Ethics, Duke University. Retrieved 8 November 2011.
  39. ^ Friedman, Jeffrey (January–February 2010). "A Perfect Storm of Ignorance". Cato Policy Report. Cato Institute. Retrieved 8 November 2011.
  40. ^ Tomlinson, Richard; Evans, David (31 May 2007). "CDO Boom Masks Subprime Losses, Abetted by S&P, Moody's, Fitch". Bloomberg L.P. Retrieved 30 August 2011.
  41. ^ Richard Cantor, Nicolas Weill, Warren Kornfel (May 2008). "Introducing assumption volatility scores and loss sensitivities for structured finance securities" (PDF). Moody's Global Credit Policy. Moody's Corporation. Retrieved 30 August 2011.{{cite web}}: CS1 maint: multiple names: authors list (link)
  42. ^ Kemba J. Dunham (18 July 2007). "Moody's Says It Is Taking Hit; Ratings Firm Loses Business as Tougher CMBS Stance Spurs Issuers to 'Rate Shop'". The Wall Street Journal.
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Category:Companies established in 1909 Category:Credit rating agencies Category:Multinational companies Category:Financial services companies based in New York City Category:Companies listed on the New York Stock Exchange

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