Bond credit rating

From Wikipedia, the free encyclopedia - View original article

External images
Summary_SPRatings_large
 
Jump to: navigation, search

In investment, the bond credit rating assesses the credit worthiness of a corporation's or government debt issues. It is analogous to credit ratings for individuals.

Contents

Table

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 Ratings to have letter designations (such as AAA, B, CC) which represent the quality of a bond. Bond ratings below BBB-/Baa are considered to be not investment grade and are colloquially called junk bonds.

Moody'sS&PFitch 
Long-termShort-termLong-termShort-termLong-termShort-term 
AaaP-1AAAA-1+AAAF1+Prime
Aa1AA+AA+High grade
Aa2AAAA
Aa3AA-AA-
A1A+A-1A+F1Upper medium grade
A2AA
A3P-2A-A-2A-F2
Baa1BBB+BBB+Lower medium grade
Baa2P-3BBBA-3BBBF3
Baa3BBB-BBB-
Ba1Not primeBB+BBB+BNon-investment grade
speculative
Ba2BBBB
Ba3BB-BB-
B1B+B+Highly speculative
B2BB
B3B-B-
Caa1CCC+CCCCCSubstantial risks
Caa2CCCExtremely speculative
Caa3CCC-Default imminent with little
prospect for recovery
CaCC
C
CD/DDD/In default
/DD
/D

Credit rating agencies

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.; Japan Credit Rating Agency, Ltd.; LACE Financial Corp.; Moody’s Investors Service, Inc.; Rating and Investment Information, Inc.; 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.[1]

S&P, Moody's, and Fitch dominate the market with approximately 90-95 percent of world market share.

Credit rating tiers

Moody's assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, with WR and NR as withdrawn and not rated.[2] Standard & Poor's and Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, D.

As of April 2011, there were 4 companies rated AAA by S&P:[3]

Moody'sStandard & Poor'sFitchCredit worthiness [4][5]
AaaAAAAAAAn 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 in 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-
CaaCCCCCCAn obligor is CURRENTLY VULNERABLE, and is dependent upon favourable business, financial, and economic conditions to meet its financial commitments.
CaCCCCAn obligor is CURRENTLY HIGHLY-VULNERABLE.
CCThe obligor is CURRENTLY HIGHLY-VULNERABLE to nonpayment. May be used where a bankruptcy petition has been filed.
CDDAn obligor has failed to pay one or more of its financial obligations (rated or unrated) when it became due.
e, pprExpectedPreliminary ratings may be assigned to obligations pending receipt of final documentation and legal opinions. The final rating may differ from the preliminary rating.
WRRating 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. [2]
unsolicitedunsolicitedThis rating was initiated by the ratings agency and not requested by the issuer.
SDRDThis 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.
NRNRNRNo 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 Standard & Poor's or Baa3 or higher by Moody's or BBB(low) or higher by DBRS. 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), when some securities, particularly mortgage backed securities (MBSs) and collateralized debt obligations (CDOs) rated highly by the credit ratings agencies, and thus heavily invested in by many organizations and individuals, were 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.

Municipal bonds

Municipal bonds, instruments issued by local, state, or federal governments in the United States, have a separate naming/classification system which mirrors the tiers for corporate bonds.

Default rates

The historical default rate for municipal bonds is lower than that of corporate bonds. The Municipal Bond Fairness Act (HR 6308),[6] introduced September 9, 2008, included the following table giving bond default rates up to 2007 for municipal versus corporate bonds by rating and rating agency.

Cumulative Historic Default Rates (in percent)
Rating categoriesMoody'sS&P
MunicipalCorporateMunicipalCorporate
Aaa/AAA0.000.520.000.60
Aa/AA0.060.520.001.50
A/A0.031.290.232.91
Baa/BBB0.134.640.3210.29
Ba/BB2.6519.121.7429.93
B/B11.8643.348.4853.72
Caa-C/CCC-C16.5869.1844.8169.19
Investment Grade0.072.090.204.14
Non-Invest Grade4.2931.377.3742.35
All0.109.700.2912.98

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.[7]

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
1981000000000000003.2800
1982000000.33000.68002.867.042.222.337.4121.43
19830000000001.332.1701.591.229.804.766.67
1984000000001.40001.641.492.133.517.6925.00
198500000000001.641.491.332.5913.118.0015.38
19860000000.7800.7801.821.181.124.6512.1616.6723.08
19870000000000000.831.315.956.8212.28
19880000000000002.331.984.509.8020.37
198900000000.900.780001.980.437.804.8831.58
199000000000.7601.102.783.064.464.8712.2622.5831.25
199100000000.830.7403.701.111.058.7216.2532.4333.87
199200000000000000.7214.9320.8330.19
1993000000000001.9201.305.884.1713.33
199400000.450000000.8601.836.583.2316.67
19950000000000.6301.551.112.768.007.6928.00
199600000000000.860.650.552.333.743.924.17
199700000000.360.340000.410.725.1914.5812.00
1998000000000.540.701.291.060.722.577.479.4642.86
19990000.3600.240.2700.280.300.541.330.904.2010.5515.4532.35
2000000000.240.5600.260.8800.802.295.6010.6611.5034.12
200100000.570.4900.240.480.270.491.196.275.9415.7423.3144.55
200200000001.110.651.311.501.744.623.699.6319.5344.12
2003000000000.190.520.480.940.271.705.169.2333.13
2004000000.23000000.640.760.462.682.8215.11
2005000000000.1700.3600.250.782.592.988.87
200600000000000.3600.480.540.781.5813.08
2007000000000000.300.230.1900.8814.81
2008000.430.400.310.210.580.180.590.711.140.630.632.973.297.0226.53
Summary statisticAAAAA+AAAA-A+AA-BBB+BBBBBB-BB+BBBB-B+BB-CCC to C
Mean000.020.030.050.060.080.160.280.280.680.891.532.447.289.9722.67
Median000000000.0800.180.830.862.066.277.6922.25
Minimum00000000000000000
Maximum000.430.400.570.490.781.111.401.333.703.067.048.7216.2532.4344.55
Standard Deviation000.080.100.140.130.200.320.360.430.960.841.832.024.517.8211.93
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
1993000000000000006.250
1994000000000000001.8500
1995000000000.43000.98000.95052.63
1996000000.15000000.6112.500031.03
1997000000000000000020.69
1998000001.040.9100.19001.03002.34022.58
19990000000.77000.3900001.54019.35
2000000000000.11000.61002.1905.26
20010.0500000.1202.2200.860.830.550.912.002.693.2726.87
2002000.0600.270.1401.770.190.701.262.031.122.503.6023.2427.03
200300000.190.030.160.200.600.500.750.841.433.281.645.1532.58
2004000000000.160.170.500.810.290.792.233.5613.79
2005000000000.080.060.150.140.450.331.342.5316.08
2006000000000.060.2000.330.360.260.361.4219.18
20070.040.030.070.0800.100.210.480.471.275.071.611.530.681.551.4724.11
20080.530.350.571.151.150.871.422.271.263.455.604.215.078.5312.8410.2856.92
Summary statisticAAAAA+AAAA-A+AA-BBB+BBBBBB-BB+BBBB-B+BB-CCC to C
Mean0.020.010.020.050.060.080.140.370.160.383.560.811.241.222.182.8316.73
Median000000000000.6100.261.55017.63
Minimum00000000000000000
Maximum0.530.350.571.151.151.041.422.271.263.4557.144.2112.508.5312.8423.2456.92
Standard Deviation0.090.070.100.230.230.240.350.760.290.7812.391.022.902.202.935.5916.60

See also

References

  1. ^ "Rating Agencies - NRSROs". Sec.gov. http://www.sec.gov/answers/nrsro.htm. Retrieved 2012-03-29. 
  2. ^ a b "Moody's Rating Symbols & Definitions" (PDF). p. 5. http://v3.moodys.com/sites/products/AboutMoodysRatingsAttachments/MoodysRatingsSymbolsand%20Definitions.pdf. Retrieved 2009-09-21. "Withdrawn - WR ... Not Rated - NR" 
  3. ^ "Microsoft’s AAA Can Withstand U.S. ‘Negative’ Outlook, S&P Says". Bloomberg(positive), downgraded (negative) or uncertain (neutral).. http://www.bloomberg.com/news/2011-04-19/microsoft-s-aaa-can-withstand-u-s-negative-outlook-s-p-says.html. 
  4. ^ "Standard & Poor's Definitions". Bankersalmanac.com. 2010-09-20. http://www.bankersalmanac.com/addcon/infobank/credit_ratings/standardandpoors.aspx. Retrieved 2012-03-29. 
  5. ^ "Individual Investors - An Educational Look at Bond Credit Ratings". Morganstanleyindividual.com. 2005-10-25. http://www.morganstanleyindividual.com/markets/bondcenter/school/credit/default.asp. Retrieved 2012-03-29. 
  6. ^ "House Report 110-835 - MUNICIPAL BOND FAIRNESS ACT". Frwebgate.access.gpo.gov. http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_reports&docid=f:hr835.110. Retrieved 2012-03-29. 
  7. ^ "Understanding Standard & Poor's Rating Definitions". standardandpoors.com. http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldata&blobtable=MungoBlobs&blobheadervalue2=inline%3B+filename%3Dunderstanding_ratings_definitions.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1243834063620&blobheadervalue3=UTF-8. 

External links

External images
Summary_SPRatings_large