Episode #23 - Credit, take two
Is this thing working? Credit isn't just about you
<center>Extra points if you know who this is…</center>Intro:
Back in 2014 I was first introduced to credit ratings as they relate to institutions. I was already on my way to credit-card hogging glory (drop a “like” if you recall the launch of 100k miles with Chase Sapphire Reserve - good times) and there was breaking news out of the Yeshiva University Commentator, our student paper: “Moody drops YU to junk bond status.” I was a student at Yeshiva College and an editor of the paper, but I wasn’t exactly sure what it meant for a university to have credit, let alone junk credit. What did that mean?
That brings me to today’s episode. Last week we got under the hood of the personal credit car and this week we’ll scope out the background and reality of corporate credit ratings.
Background:
For the catch up on history: In the same vein as last week regarding an individual’s likelihood of paying back debt, credit agencies emerged in the wake of the financial crisis of 1837 (h/t Wikipedia). The agencies needed to analyze a company/merchant’s ability to pay back their debts and gathered the “ratings” together in pamphlets for lenders to use and inform their lending decisions.
Interestingly, Lewis Tappan established the first agency that did this type of work and he was an early supporter of the abolitionist movement - on that note I recommend A Slave’s Cause: A History of Abolition that covers some of his work on that front.
Shortly thereafter, John Moody (yes, today’s Moody’s) and Henry Varnum Poor’s (of Standard and Poor’s aka the S&P) were on the scene publishing ratings for railroad companies who were most likely and least likely to pay back their debts.
A deeper dive:
Today, credit rating agencies (like Moody’s and S&P) provide an additional angle to a company’s likely success or failure, specifically focusing on their debt. For example, Tesla has been climbing out of “junk” rating status from a number of agencies based on their strong performance over the last year or so (see here for the article).
For a sense of the different ratings and what they mean, check out the chart before from our friends at Investopedia:
Yes, it does feel like they realized shortly after they started making ratings that they needed more ratings in between, but what can I say. What I believe is most challenging about this field is that they don’t use numerics to indicate their ratings and they quite explicitly say that parts of the ratings are subjective and based on their own analysis. For example, this language from a disclaimer about accuracy of the ratings:
The ratings ... are and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell, or hold any securities.
Yes, this is a bit surprising and there is a little more: in the 2001 financial crisis many criticized the ratings agencies because they didn’t adjust their ratings of Enron even as the company was swiftly falling out of favor in the markets.
Takeaway:
Why care so much about the credit ratings of a company? Well, so much about companies or suites of companies you invest in doesn’t get to the investor’s desk without a fair amount of work. The hope is that these ratings agencies get you as good information as you can find to assist smaller investors as well as helps companies secure investments from larger entities that want more security or even higher risk in some cases to get a higher reward from their investment.
After 2008’s financial crisis, a few pieces of legislation were put into effect that raised the bar for ratings agencies, so on the whole the data you’re getting from them should still be super helpful in enabling you to better understand a company you invest in.
Interact:
Find a company you’ve heard about, care about, or might want to invest in. Find their credit rating and send it back to me! (Yes, this is challenging because there are a few different ratings agencies :))
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