The Shortcomings of Traditional Credit Rating Agencies

Despite their long-standing role in financial markets, traditional credit rating agencies face significant shortcomings, particularly in providing timely and unbiased credit assessments. For sophisticated investors navigating the corporate bond market, these limitations can distort the value risk assessments and introduce an element of doubt about the impartiality of research.

Gimme Credit takes a forward-looking approach that delivers more real-time insights. Free from many of the industry constraints traditional agencies struggle with, we are able to provide a truly unbiased, unhedged, independent view of corporate bonds based on a value-driven, bottom-up approach.

Traditional credit rating agencies like Moody’s, S&P, and Fitch often follow a reactive model, updating credit ratings only after significant corporate events or quarterly reviews. This approach is not delivering and needs to be revised to accommodate a more dynamic corporate bond market, where credit spreads, yield curves, and market liquidity can shift rapidly. These delays in updating credit ratings can lead to mispriced credit risk for high-yield or investment-grade corporate bond investors.

Among the core considerations when evaluating credit ratings and credit scores is the type of income model used and whether this can create conflicts of interest.

Issuer-Pay Model

Credit rating agencies operate on an “issuer-pay” model, meaning the issuer compensates the agency. This presents a conflict of interest, where agencies might feel pressured to issue favorable ratings to retain business, potentially inflating ratings for corporate bonds that carry significant credit risk.

Investor-Pay Model

Conventional ratings often need to catch up in reacting to changing market conditions, such as deteriorating cash flow and rising default risks. For instance, in distressed bond markets, traditional ratings may fail to respond quickly enough to shifts in market liquidity, the widening of credit spreads, or deteriorating earnings coverage ratios. This can leave investors exposed to undue risk.

While there are instances where a reactive approach is unavoidable (although speed is still of the essence), a proactive approach to changing circumstances where possible provides greater value to investors.

Proactive Credit Scoring and Analysis

Gimme Credit’s proprietary internal credit scores are refreshed as and when required, taking into account current market dynamics such as credit default swap spreads, leverage ratios, and liquidity metrics. This forward-looking, real-time analysis ensures bond investors receive more timely and accurate credit risk assessments and avoids the typical delays seen in traditional agencies.

Independence from Issuer Influence

By avoiding the issuer-pay model, Gimme Credit mitigates bias. Instead, it focuses on objective, market-based data and internal risk models free from the pressures of issuer relationships. This ensures a more transparent assessment of bond risk, and our accompanying data sheets add a further layer of transparency.

Evidence of improved accuracy

On many occasions, our proactive and independent approach to corporate bond research has enabled us to identify changing credit risks before the traditional credit rating agencies.

Recent Case Studies: Predicting Credit Deterioration

In the recent market downturn, Gimme Credit accurately predicted credit downgrades for several high-yield issuers before traditional rating agencies reacted. For example, in 2024, Gimme Credit downgraded Company X’s bonds two months before the traditional agencies, identifying deteriorating interest coverage ratios and escalating refinancing risks, enabling investors to adjust their portfolios accordingly.

There are many factors to consider when comparing and contrasting traditional credit rating agencies and independent research houses. They differ in several ways, including:-

Rating frequency

Traditional Rating Agencies: Quarterly or event-driven
Gimme Credit: Our credit scores last 6 months but are revisited every 3 months

Potential conflicts of interest

Traditional Rating Agencies: Issuer pays model – potential outside influence
Gimme Credit: Independence

Response to market changes

Traditional Rating Agencies: Reactive, lagging
Gimme Credit: Proactive adjustments

Risk factors considered

Traditional Rating Agencies: Limited (e.g., financial ratios)
Gimme Credit: Holistic approach (e.g. market-based indicators, leverage and liquidity metrics)

While there are many differences between traditional credit rating agencies and independent research houses, such as Gimme Credit, for sophisticated investors, the main focus is independent, unbiased, and unhedged research. These have been the core fundamentals of Gimme Credit since its inception in 1994.