Definition of rating agencies
Rating agencies, or credit rating agencies, evaluate the creditworthiness of organisations that issue debt in public markets. This includes the debts of corporations, nonprofit organisations, and governments, as well as “securitised assets” – which are assets that are bundled together and sold as a security to investors. Rating agencies assign a letter grade to each bond, which represents an opinion as to the likelihood that the organisation will be able to repay both the principal and interest as they become due.
Ratings are made on a descending scale: AAA is the highest, then AA, A, BBB, BB, B, etc. A rating of BB or below is considered a “junk bond,” because it is likely to default. Many factors go into the assignment of ratings, including the profitability of the organisation and its total indebtedness. The three largest credit rating agencies are Moody’s, Standard & Poor’s, and Fitch Ratings.
There are very few AAA rated companies in the world. Examples include ExxonMobil, Johnson & Johnson, and Microsoft. The governments of the United States, the United Kingdom, and Germany are also rated AAA. Organisations with a AAA rating are able to issue debt at very low interest rates.
There are many companies with low credit ratings. General Motors had a “junk” credit rating for many years before it declared bankruptcy in 2009. Companies with a low credit rating generally pay a much higher interest rate on their debt, and may find it difficult to sell new bonds. The methodology of the ratings agencies is not without flaws, and they are under considerable scrutiny regarding the inaccuracy of many ratings categories during the financial crisis.