What is Moody's?

Moody's is one of the oldest and largest credit rating agencies in the world, part of the "big three" along with two other leading international agencies. The company was founded in the USA in the early 20th century, with headquarters in New York. Today, the group comprises two divisions: a credit ratings division and an analytics division that develops data, models, and software solutions for risk assessment.

Moody's ratings express the agency's opinion on the credit risk of a borrower. The approach's distinctive feature is that the assessment considers not only the probability of default but also the expected losses to an investor if default occurs.

Moody's Rating Scale

Unlike other agencies, Moody's uses its own notation system: a combination of letters and numerical modifiers 1, 2, and 3. The figure 1 means the upper part of the category, 3 means the lower part.

  • Aaa — highest reliability, minimal credit risk.
  • Aa, A — high and above-average reliability.
  • Baa — average reliability, lower bound of investment grade (Baa3).
  • Ba, B — speculative category with significant credit risk.
  • Caa, Ca — very high risk, borrower is near default or already in default.
  • C — lowest rating: typically default with low recovery chances.

A separate scale applies to short-term obligations: P-1, P-2, P-3, and NP (Not Prime) — for issuers outside the highest categories.

Outlook and Rating Review

In addition to the rating itself, Moody's publishes an outlook: "positive," "stable," "negative," or "developing." It indicates the probable direction of rating change. If the agency considers a rating change likely in the near term, the issuer is placed under review for possible upgrade or downgrade.

How Ratings Are Assigned

Analysts examine financial statements, debt structure, business model, industry positions, and management quality. For countries, economic and institutional strength, government financial position, and exposure to various risks are assessed. A rating committee makes the final decision, and the result is published with rationale. Typically, the issuer seeking a rating to access capital markets pays for the agency's services.

Why an Investor Needs Moody's Rating

  • Quick reliability assessment. A rating allows comparing bonds of different issuers on a single scale.
  • Connection to yield. The lower the rating, the higher the risk premium investors demand.
  • Fund restrictions. Many pension and insurance funds can only purchase investment-grade securities.
  • Borrowing costs. Rating upgrade reduces debt costs for the issuer; downgrade makes it more expensive.

Pros and Cons for Investors

Pros:

  • Detailed scale with numerical modifiers allows more precise differentiation of borrowers.
  • Accounting for expected losses provides a more complete risk picture.
  • The agency has long-term default statistics on which its assessments rely.

Cons:

  • A rating is the agency's opinion, not a guarantee of repayment.
  • Assessments may lag behind real changes in an issuer's position.
  • Issuer payment for services creates potential conflicts of interest.
  • Scale notations differ from other agencies, requiring care when comparing.