How do i get a credit rating

how do i get a credit rating

1 Answer

Quora User. Alchemist & Metaphysician

A Duopoly

Just three companies provide about 98 percent of all financial product, corporate and government credit ratings. These ratings are critical for bond offering as the cost of money will raise and fall based on these ratings. The top two rating companies dominate as a duopoly with about 78% of total market share. There are many reasons for this, the primary reason is marketability of a particular bond offering to be considered “investment grade" it is just about required that there are two ratings.

This means that the entity producing the offering will likely have to contract with, and pay fees to, two rating companies for a typical offering. Thus it is expected that there must be reasonable rating from Standard & Poor's and Moody’s Investors Service before any professional money manager would consider the offering. There of course are exceptions but without a rating by one if not both rating companies, costs of money will go quite high.

Rising Costs, Little Competition

Because of the duopoly, there is little variation in costs for the services rendered by these companies. Rates have been raising consistently above inflation for the last thirty years. With the last five years seeing larger increase in the cost of services. The costs for services rendered are not exactly standardized across all industries and financial products. There are also menus of additional onetime fees and ongoing fees that all rating services charge. Typically the more work involved to perform the service the higher the fee. How these fees apply are based on many factors of the particular relationship. In this example here are the very basic costs that a public works bond may incur:

  • Standard & Poor’s - 42% market share. Cost 4.95 basis points of the total amount of the bond offering or $80,000 whatever amount is grater.
  • Moody’s Investors Service - 37% market share. Cost 5 basis points of the total amount of the bond offering or $73,000 whatever amount is grater.

There are of course a number of smaller rating services and in some sectors they have greater market share, for example

Morningstar. However the vast majority of transactions go to the duopoly. In the case of A.M. Best, they dominate Insurance ratings and also have a number of other offerings and really are not in the same market as Standard & Poor’s and Moody’s Investors Service.

Breaking The Duopoly

The Dodd-Frank act tried to break away from the use of ratings companies. However Basel III, an international bank capital standard require ratings from the ratings company to be in full compliance.

At least for the foreseeable future, there seems that little will change for the current duopoly even as many question the quality of the ratings particularly over the last five years. There is a rather insightful paper, The Financial Crisis and Credibility of Corporate Credit Ratings [1] from Ed deHaan of the University of Washington that illuminates this quite well.

Abstract

Credit ratings on certain structured finance products significantly underestimated default risk prior to the recent financial crisis. Rating agency executives acknowledge that these failures damaged the agencies’ credibility with respect to credit ratings on structured finance products. I investigate whether the agencies’ credibility with respect to corporate credit ratings also suffers as a result of the financial crisis.

I document a decline in the information content of corporate credit rating changes from mid-2007 onward, accompanied by a decline in the relevance of credit ratings for debt price levels. At the same time, there is a significant increase in the information content of quarterly earnings releases.

These findings are consistent with market participants placing less (more) weight on corporate ratings (accounting information) in debt pricing as corporate credit ratings are viewed as less credible in the post-crisis period. Additional tests are consistent with corporate ratings being viewed as optimistically biased as opposed to simply inaccurate. Most directly, my study provides insight as to the credibility effects of the financial crisis on the credit rating agencies. More broadly, my findings provide new empirical evidence on the relation between credit rating credibility and usage, and also inform the literature about the substitutability between corporate credit ratings and accounting information in debt pricing.

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Category: Credit

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