Bond credit rating

In investment, the bond credit rating represents the credit worthiness of corporate or government bonds. It is not the same as an individual's credit score. The ratings are published by credit rating agencies and used by investment professionals to assess the likelihood the debt will be repaid.

Credit rating agencies

Credit rating is a highly concentrated industry with the "Big Three" credit rating agenciesFitch Ratings, Moody's and Standard & Poor's (S&P) – controlling approximately 95% of the ratings business.[1][2]

Credit rating agencies registered as such with the SEC are "nationally recognized statistical rating organizations". The following firms are currently registered as NRSROs: A.M. Best Company, Inc.; DBRS Ltd.; Egan-Jones Rating Company; Fitch, Inc.; HR Ratings; Japan Credit Rating Agency; Kroll Bond Rating Agency; Moody's Investors Service, Inc.; Rating and Investment Information, Inc.; Morningstar Credit Ratings, LLC; and Standard & Poor's Ratings Services.

Under the Credit Rating Agency Reform Act, an NRSRO may be registered with respect to up to five classes of credit ratings: (1) financial institutions, brokers, or dealers; (2) insurance companies; (3) corporate issuers; (4) issuers of asset-backed securities; and (5) issuers of government securities, municipal securities, or securities issued by a foreign government.[3]

In Asia, the regulated and recognized credit rating agencies in the domestic markets are – in China: China Chengxin International (CCXI), China Lianhe Credit Rating (Lianhe Ratings), New Century Zixin Assessment Investment Service, Pengyuan Credit Rating; in Japan: Rating and Investment Information (R&I); in India: ICRA (ICRA), Credit Analysis and Research (CARE) and CRISIL.

Credit rating codes and classes

The credit rating is a financial indicator to potential investors of debt securities such as bonds. These are assigned by credit rating agencies such as Moody's, Standard & Poor's, and Fitch, which publish code designations (such as AAA, B, CC) to express their assessment of the risk quality of a bond. Moody's assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, as well as WR and NR for 'withdrawn' and 'not rated' respectively.[4] Standard & Poor's and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, D. Currently there are only two companies in the United States with an AAA credit rating: Microsoft and Johnson & Johnson.[5] These individual codes are grouped into broader classes described as "investment grade" or not, or in numbered tiers from high to low.

In addition to the rating codes, agencies typically supplement the current assessment with indications of the chances for future upgrades or downgrades over the medium term. For example, Moody's designates an Outlook for a given rating as Positive (POS, likely to upgrade), Negative (NEG, likely to downgrade), Stable (STA, likely to remain unchanged), or Developing (DEV, contingent on some future event).[6]

Moody's S&P Fitch Equivalent to SVO Designations Rating description
Long-term Short-term Long-term Short-term Long-term Short-term NAIC
AaaP-1 AAAA-1+ AAAF1+ 1 PrimeInvestment-grade
Aa1AA+AA+ High grade
Aa2AAAA
Aa3AA−AA−
A1 A+A-1 A+F1 Upper medium grade
A2AA
A3P-2 A−A-2 A−F2
Baa1BBB+BBB+ 2 Lower medium grade
Baa2P-3 BBBA-3 BBBF3
Baa3BBB−BBB−
Ba1Not prime BB+B BB+B 3 Non-investment grade
speculative
Non-investment grade
AKA high-yield bonds
AKA junk bonds
Ba2BBBB
Ba3BB−BB−
B1B+B+ 4 Highly speculative
B2BB
B3B−B−
Caa1 CCC+C CCCC 5 Substantial risks
Caa2CCCExtremely speculative
Caa3CCC− Default imminent with little
prospect for recovery
CaCC 6
C
C D/ DDD/ In default
/ DD
D

Rating tier definitions

Moody's S&P Fitch Credit worthiness[7][8]
AaaAAAAAA An obligor has extremely strong capacity to meet its financial commitments.
Aa1AA+AA+ An obligor has very strong capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.
Aa2AAAA
Aa3AA−AA−
A1A+A+ An obligor has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
A2AA
A3A−A−
Baa1BBB+BBB+ An obligor has adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.
Baa2BBBBBB
Baa3BBB−BBB−
Ba1BB+BB+ An obligor is less vulnerable in the near term than other lower-rated obligors. However, it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions which could lead to the obligor's inadequate capacity to meet its financial commitments.
Ba2BBBB
Ba3BB−BB−
B1B+B+ An obligor is more vulnerable than the obligors rated 'BB', but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments.
B2BB
B3B−B−
CaaCCCCCC An obligor is currently vulnerable, and is dependent upon favourable business, financial, and economic conditions to meet its financial commitments.
CaCCCC An obligor is currently highly vulnerable.
CC The obligor is currently highly vulnerable to nonpayment. May be used where a bankruptcy petition has been filed.
CDD An obligor has failed to pay one or more of its financial obligations (rated or unrated) when it became due.
e, pprExpected Preliminary ratings may be assigned to obligations pending receipt of final documentation and legal opinions. The final rating may differ from the preliminary rating.
WRWD Rating withdrawn for reasons including: debt maturity, calls, puts, conversions, etc., or business reasons (e.g. change in the size of a debt issue), or the issuer defaults. [4]
UnsolicitedUnsolicited This rating was initiated by the ratings agency and not requested by the issuer.
SDRD This rating is assigned when the agency believes that the obligor has selectively defaulted on a specific issue or class of obligations but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner.
NRNRNR No rating has been requested, or there is insufficient information on which to base a rating.

Investment grade

A bond is considered investment grade or IG if its credit rating is BBB− or higher by Fitch Ratings or S&P, or Baa3 or higher by Moody's, the so-called "Big Three" credit rating agencies. Generally they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them.

Ratings play a critical role in determining how much companies and other entities that issue debt, including sovereign governments, have to pay to access credit markets, i.e., the amount of interest they pay on their issued debt. The threshold between investment-grade and speculative-grade ratings has important market implications for issuers' borrowing costs.

Bonds that are not rated as investment-grade bonds are known as high yield bonds or more derisively as junk bonds.

The risks associated with investment-grade bonds (or investment-grade corporate debt) are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market's belief in the stability of the economy. The higher these investment-grade spreads (or risk premiums) are, the weaker the economy is considered.

Criticism

Until the early 1970s, bond credit ratings agencies were paid for their work by investors who wanted impartial information on the credit worthiness of securities issuers and their particular offerings. Starting in the early 1970s, the "Big Three" ratings agencies (S&P, Moody's, and Fitch) began to receive payment for their work by the securities issuers for whom they issue those ratings, which has led to charges that these ratings agencies can no longer always be impartial when issuing ratings for those securities issuers. Securities issuers have been accused of "shopping" for the best ratings from these three ratings agencies, in order to attract investors, until at least one of the agencies delivers favorable ratings. This arrangement has been cited as one of the primary causes of the subprime mortgage crisis (which began in 2007); some securities, particularly mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs), were rated highly by the credit ratings agencies and thus heavily invested in by many organizations and individuals, but were then rapidly and vastly devalued due to defaults, and fear of defaults, on some of the individual components of those securities, such as home loans and credit card accounts. Other countries are beginning to mull the creation of domestic credit ratings agencies to challenge the dominance of the "Big Three", for example in Russia, where the ACRA was founded in 2016.[9]

Municipal bonds

Municipal bonds are instruments issued by local, state, or federal governments in the United States. Until April–May 2010, Moody's and Fitch were rating municipal bonds on the separate naming/classification system which mirrored the tiers for corporate bonds. S&P abolished its dual rating system in 2000.

Default rates

The historical default rate for municipal bonds is lower than that of corporate bonds. A potential misuse of historic default statistics is to assume that historical average default rates represent the "probability of default" of debt in a particular rating category. However, [...] default rates can vary significantly from one year to the next and the observed rate for any given year can vary significantly from the average.[10]

AAA Rating

AAA is the highest credit rating that any of the major credit rating agencies can give to an issuer's bonds.

AAA Rated Bonds

AAA-rated bonds have a high credit rating because their issuers are able to meet their financial obligations with ease and have the lowest risk of default.

Standard & Poor's one-year global corporate default rates by refined rating category, 1981–2008
YearAAAAA+AAAA−A+AA−BBB+BBBBBB−BB+BBBB−B+BB−CCC to C
1981 000000000000003.2800
1982 000000.33000.68002.867.042.222.337.4121.43
1983 0000000001.332.1701.591.229.804.766.67
1984 000000001.40001.641.492.133.517.6925.00
1985 00000000001.641.491.332.5913.118.0015.38
1986 0000000.7800.7801.821.181.124.6512.1616.6723.08
1987 0000000000000.831.315.956.8212.28
1988 0000000000002.331.984.509.8020.37
1989 00000000.900.780001.980.437.804.8831.58
1990 00000000.7601.102.783.064.464.8712.2622.5831.25
1991 00000000.830.7403.701.111.058.7216.2532.4333.87
1992 00000000000000.7214.9320.8330.19
1993 000000000001.9201.305.884.1713.33
1994 00000.450000000.8601.836.583.2316.67
1995 0000000000.6301.551.112.768.007.6928.00
1996 00000000000.860.650.552.333.743.924.17
1997 00000000.360.340000.410.725.1914.5812.00
1998 000000000.540.701.291.060.722.577.479.4642.86
1999 0000.3600.240.2700.280.300.541.330.904.2010.5515.4532.35
2000 000000.240.5600.260.8800.802.295.6010.6611.5034.12
2001 00000.570.4900.240.480.270.491.196.275.9415.7423.3144.55
2002 00000001.110.651.311.501.744.623.699.6319.5344.12
2003 000000000.190.520.480.940.271.705.169.2333.13
2004 000000.23000000.640.760.462.682.8215.11
2005 000000000.1700.3600.250.782.592.988.87
2006 00000000000.3600.480.540.781.5813.08
2007 000000000000.300.230.1900.8814.81
2008 000.430.400.310.210.580.180.590.711.140.630.632.973.297.0226.53
SummaryAAAAA+AAAA−A+AA−BBB+BBBBBB−BB+BBBB−B+BB−CCC to C
Mean 000.020.030.050.060.080.160.280.280.680.891.532.447.289.9722.67
Median 000000000.0800.180.830.862.066.277.6922.25
Minimum 00000000000000000
Maximum 000.430.400.570.490.781.111.401.333.703.067.048.7216.2532.4344.55
Standard
deviation
000.080.100.140.130.200.320.360.430.960.841.832.024.517.8211.93
Standard & Poor's one-year global structured finance default rates by refined rating category, 1978–2008
YearAAAAA+AAAA−A+AA−BBB+BBBBBB−BB+BBBB−B+BB−CCC to C
1993 000000000000006.2500
1994 000000000000001.8500
1995 000000000.43000.98000.95052.63
1996 000000.15000000.6112.500031.03
1997 000000000000000020.69
1998 000001.040.9100.19001.03002.34022.58
1999 0000000.77000.3900001.54019.35
2000 000000000.11000.61002.1905.26
2001 0.0500000.1202.2200.860.830.550.912.002.693.2726.87
2002 000.0600.270.1401.770.190.701.262.031.122.503.6023.2427.03
2003 00000.190.030.160.200.600.500.750.841.433.281.645.1532.58
2004 000000000.160.170.500.810.290.792.233.5613.79
2005 000000000.080.060.150.140.450.331.342.5316.08
2006 000000000.060.2000.330.360.260.361.4219.18
2007 0.040.030.070.0800.100.210.480.471.275.071.611.530.681.551.4724.11
2008 0.530.350.571.151.150.871.422.271.263.455.604.215.078.5312.8410.2856.92
SummaryAAAAA+AAAA−A+AA−BBB+BBBBBB−BB+BBBB−B+BB−CCC to C
Mean 0.020.010.020.050.060.080.140.370.160.383.560.811.241.222.182.8316.73
Median 000000000000.6100.261.55017.63
Minimum 00000000000000000
Maximum 0.530.350.571.151.151.041.422.271.263.455.64.2112.508.5312.8423.2456.92
Standard
deviation
0.090.070.100.230.230.240.350.760.290.7812.391.022.902.202.935.5916.60

See also

References

  1. Alessi, Christopher. "The Credit Rating Controversy. Campaign 2012". Council on Foreign Relations. Archived from the original on 27 July 2013. Retrieved 29 May 2013.
  2. Report on CRA Market Share Calculation, European Securities and Markets Authority, November 2018, Archived 25 December 2018 at the Wayback Machine
  3. "Rating Agencies - NRSROs". Sec.gov. Retrieved 2012-03-29.
  4. "Moody's Rating Symbols & Definitions" (PDF). p. 5. Archived from the original (PDF) on 2010-09-22. Retrieved 2009-09-21. Withdrawn - WR ... Not Rated - NR
  5. "Apple Upgraded to Top Bond Rating by Moody's on Growth Prospects". Bloomberg. 21 December 2021.
  6. "Glossary of Moody's Rating Terms". CreditRiskMonitor. Retrieved August 20, 2019.
  7. "Standard & Poor's Definitions". Bankersalmanac.com. 2010-09-20. Retrieved 2012-03-29.
  8. "Individual Investors – An Educational Look at Bond Credit Ratings". Morganstanleyindividual.com. 2005-10-25. Retrieved 2012-03-29.
  9. Contextualizing Russia's Ratings Agency: ACRA. Emerging Market Fiscal Oversight and Governance Mechanisms. Social Science Research Network. Accessed 27 August 2017.
  10. "Understanding Standard & Poor's Rating Definitions". standardandpoors.com.
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