Moodys Bank Financial Strength Ratings

In the past few days there have been many news flashes about Moody's changing the Bank Financial Strength Ratings for banks in India. The most significant of which was, the downgrading of State Bank of India, the nations premier state owned banking institution from C- to D+. This caused shock waves across the stock market and the SBI shares tumbled to their 2 year low.

The purpose of this post is to understand what this Bank Financial Strength Rating is and understand the different ratings available.

What is this Bank Financial Strength Rating?

"Moody's Bank Financial Strength Ratings reflect Moody's opinion of a bank's intrinsic or stand-alone financial strength relative to all other rated banks globally."

This BFSR is a measure of the likelihood that a bank will require financial assistance in order to avoid a default.

What are the different Ratings available?

Rating Name	Rating Description
A	Banks rated A possess superior intrinsic financial strength. Typically, they will be institutions with highly valuable and defensible business franchises, strong financial fundamentals, and a very predictable and stable operating environment.
B	Banks rated B possess strong intrinsic financial strength. Typically, they will be institutions with valuable and defensible business franchises, good financial fundamentals, and a predictable and stable operating environment.
C	Banks rated C possess adequate intrinsic financial strength. Typically, they will be institutions with more limited but still valuable business franchises. These banks will display either acceptable financial fundamentals within a predictable and stable operating environment, or good financial fundamentals within a less predictable and stable operating environment.
D	Banks rated D display modest intrinsic financial strength, potentially requiring some outside support at times. Such institutions may be limited by one or more of the following factors: a weak business franchise; financial fundamentals that are deficient in one or more respects; or an unpredictable and unstable operating environment.
E	Banks rated E display very modest intrinsic financial strength, with a higher likelihood of periodic outside support or an eventual need for outside assistance. Such institutions may be limited by one or more of the following factors: a weak and limited business franchise; financial fundamentals that are materially deficient in one or more respects; or a highly unpredictable or unstable operating environment.

A point to note is that wherever appropriate, a "+" modifier will be appended to ratings below the "A" category and a "-" modifier
will be appended to ratings above the "E" category to distinguish those banks that fall in intermediate categories. So, a B+ is better than a B and a C- is better than a D.

This post is just the introduction about these Banking Financial Strength Ratings. Watch out for more articles on how it is calculated in future!!!

What is a Credit Rating?

A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by credit rating agency of the debt issuers likelihood of default

Credit ratings are determined by credit ratings agencies. The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies analysts. Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government. The credit rating is used by individuals and entities that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations.

What are the agencies that provide Credit Ratings?

Though each bank may have an internal rating system for large organizations and sovereign parties (Countries), the 3 most important or widely accepted rating agencies are:

1. Standard & Poors
2. Moody's
3. Fitch

A point to note is that the above agencies are not in any order of importance and the ratings by each agency is considered with equal importance. If two or more agencies provide a rating for a party, then it is widely accepted as the credit worthiness of the party.

What are the Rating Bands?

The rating bands issued by the rating agencies are grouped as follows:

1. Prime Investment Grade
2. High Investment Grade
3. Medium Grade
4. Speculative/Risky
5. High Risk
6. In Default

Where are these Ratings used?

These are used when investors buy debt instruments (bonds) issued by these parties. If I were to invest my money in a bond and I have 3 options, one Prime, one Medium and one High Risk, I will obviously choose the Prime rated company's bonds because, they are the least risky and they will repay the money they owe me in due time without any delays or defaults.

However, if the rating is not prime and falls in the other categories, companies usually offer a higher rate of interest to attract investors to invest in them (even though they are risky)

Remember the Risk - Return matrix? Higher the risk, higher the returns. Obviosly, there is a risk that the party may default, but they pay more nonetheless.

What are the actual Ratings?

Based on the Rating Bands that we just saw, the ratings from the respective agencies are:

Prime Investment Grade: No Risk of Default

Rating Agency	Rating
S&P	AAA
Moody	Aaa
Fitch	AAA

High Investment Grade:

Rating Agency	Rating
S&P	AA+, AA, AA-
Moody	Aa1, Aa2, Aa3
Fitch	AA+, AA, AA-

Upper Medium Grade:

Rating Agency	Rating
S&P	A+, A
Moody	A1, A2
Fitch	A+, A

Lower Medium Grade:

Rating Agency	Rating
S&P	A-, BBB+, BBB, BBB-
Moody	A3, Baa1, Baa2, Baa3
Fitch	A-, BBB+, BBB, BBB-

Non Investment Grade/Speculative:

Rating Agency	Rating
S&P	BB+, BB, BB-
Moody	Ba1, Ba2, Ba3
Fitch	BB+, BB, BB-

Highly Speculative:

Rating Agency	Rating
S&P	B+, B, B-
Moody	B1, B2, B3
Fitch	B+, B, B-

Extremely Risky:

Rating Agency	Rating
S&P	CCC+, CCC, CCC-, CC, C
Moody	Caa1, Caa2, Caa3, Ca
Fitch	CCC

In Default:

Rating Agency	Rating
S&P	D
Moody	C
Fitch	DDD, DD, D

As you can see, AAA is the best and D is probably the worst possible credit rating you can get.