Everyone is familiar with the symbols that the two credit rating giants—Standard & Poor’s Ratings Group
and Moody’s Investors Service—use in their ratings. These symbols have been in widespread use since John Moody
introduced the first bond ratings of railroads back in 1909. For issues or issuers of investment-grade quality, S&P assigns
the ratings AAA, AA, A, and BBB, while Moody’s uses Aaa, Aa, A, and Baa. (Both agencies introduced rating modifiers
in the early 1980’s, S&P using plus and minus signs and Moody’s using 1, 2, and 3). For issues or issuers
of non-investment-grade quality, S&P assigns ratings of BB, B, CCC, CC, C, and D, while Moody’s uses Ba, B, Caa,
Ca, and C (again with modifiers).
What do these symbols stand for? The short answer is—the risk
that an issuer will default on an obligation. The higher the rating, the less likely the chance of default, which is defined
simply as an issuer’s not making a payment of principal or interest on time. A triple-A rating means the issuer has
an "extremely strong capacity to pay interest and repay principal on time," according to S&P’s definition, whereas
near the other end of the scale, a C rating means a "high risk of default or reliance on third parties to prevent default."
Since even people on Wall Street can misunderstand the meaning of ratings, the agencies like to emphasize that ratings
are informed opinions of credit risk, not currency risk, prepayment risk, interest rate risk or liquidity risk. Ratings are
neither guarantees against default nor recommendations to trade certain securities.
Who Benefits From Ratings?
Ratings have persisted for almost a century
because they serve a useful purpose. All participants in the capital markets benefit from ratings:
with either investment-grade or non-investment grade ratings can broaden their market access and their investor base, they
can achieve lower-cost funding, and they can increase their financial flexibility.
Investors find ratings
to be reliable guides to default risk, assisting them in investment comparisons and sound portfolio management.
like ratings because ratings help promote market efficiency by reducing arbitrage and market volatility based on rumor.
Ratings help assure the stability of the financial system.
Intermediaries such as the investment banks use
ratings to help them plan, price and place securities.
Ratings Advisors, such as GIA, benefit because the
rating process can be confusing, mysterious and complex for even seasoned issuers. GIA helps issuers understand the process
and thereby optimize their ratings. Indirectly, GIA is also helping the rating agencies do their work more efficiently, because
an issuer’s presentations to the agencies will be more organized and more focused on key issues, saving time for the
Understanding and Managing the Credit Rating Agencies:
A Guide for Fixed Income Issuers
NEW BOOK BY ROGER NYE
- How to
achieve an optimal credit rating
- An insider's view on how the rating agencies think and operate
- The rights,
wrongs and rules of credit ratings
- A first-time explanation of the business and inner workings of the credit ratings
- Behind and beyond the agencies' public websites
- The role of quantitative and qualitative factors
in the rating decision
- The assumptions that anchor agency perspectives on banks, corporations and governments
to do and what not to do in the annual due diligence meeting with the agencies
- The dynamics of decision making
in the Rating Committee
- Issuer rights and leverage in rating agency relations
- An influential guide
to strategies and tactics for issuers
- Published by Euromoney Books March 2014