Ah Spring! When a young man’s fancy turns to . . . bond ratings?
On the Money
From the May 7, 2004 print edition
[“In the spring a young man’s fancy lightly turns to thoughts of love.” This line is from the poem, “Locksley Hall,” by Alfred, Lord Tennyson. However, spring also brings thoughts of other things-like] how, after paying all those taxes last month, can we make more money than last year?
One way is to pay more attention to the credit rating of companies in which we invest. In financial circles “AAA” does not mean American Automobile Association. Likewise “CC” does not stand for “Carbon Copy;”
Here’s a brief look at those ratings; where they come from, and what they mean.
Over one hundred years ago, after Moody was wiped out in the 1907 stock market crash, he came back with an idea: this time an analysis of security values for investors. Thus was born Moody’s Investors Service, the world’s largest rating agency, which now has more than 700 analysts working in 14 countries.
Standard & Poor’s, a division of The McGraw-Hill Companies, was established in 1860, to provide independent insight, analysis and information to the financial community. Along with Moody’s, Standard & Poor’s is a pre-eminent global provider of independent financial analysis and information.
Moody’s and S&P’s dominate the US market, where ratings have for decades been vital tools for issuers and investors. But, with the advent of the euro bond market, European investors are becoming more rating conscious.
Ratings are basically tools for differentiating credit quality. Standard & Poor’s defines a rating as an “opinion on the general creditworthiness of an obligor.” The rating process includes quantitative, qualitative and legal analysis.
Moody’s long-term rating definitions range from Aaa to C, or from golden-edged bonds to those having extremely poor prospects of ever attaining any solid investment standing. On this scale, any bonds below Ba generally lack characteristics of a desirable investment.
Rating is largely what determines the borrower’s ability to raise money by issuing debt (Bonds) on favorable terms.
The actual ratings definitions are:
Moody’s Long-Term Debt Ratings
- Aaa: Best quality. Smallest degree of risk. “Gilt edged”. Interest payments protected by a large or very stable margin and principal is secure.
- Aa: Of high quality by all standards. Margins of protection may not be as large as Aaa or fluctuation of protective elements may be of greater amplitude.
- A: Many favorable attributes; upper-medium-grade obligations. Security considered adequate, but may be susceptible to impairment in the future.
- Baa: Medium-grade obligations neither highly protected nor poorly secured. Security appears adequate at present but certain protective elements may be unreliable over any great length of time. Speculative characteristics.
- Ba: Judged to have speculative elements; future cannot be considered as well-assured. The protection of interest and principal payments may be very moderate and not well safeguarded during both good and bad times.
- B: General lacks characteristics of a desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small.
- Caa: Of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest.
- Ca: Speculative in a high degree. Such issues are often in default or have other marked shortcomings.
- C: Extremely poor prospects of ever attaining any real investment standing.
Standard & Poor’s Long-Term Issuer Credit Ratings
- AAA: Extremely strong capacity to meet its financial commitments. The highest Issuer Credit Rating assigned by Standard & Poor’s.
- AA: Very strong capacity to meet its financial commitments. It differs from the highest rated obligors only in small degree.
- A: Strong capacity to meet its financial commitments but is somewhat more susceptible to changes in circumstances.
- BBB: Adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to meet its financial commitments.
- BB: BB, B, CCC, and CC rating have significant speculative characteristics. BB is less vulnerable near term but faces major uncertainties; adverse conditions could lead to inadequate capacity to meet commitments.
- B: More vulnerable than obligors rated BB, but currently has the capacity to meet financial commitments. Adverse conditions will likely impair the obligor’s capacity or willingness to meet its financial commitments.
- CCC: Currently vulnerable and is dependent upon favorable business, financial, and economic conditions to meet financial commitments.
- CC: Currently highly vulnerable.
[To paraphrase a well-known love-song, Just remember in the winter, far beneath the bitter snow, lies the “CC,” That with careful analysis, in the spring becomes the AAA.”]
© C. Stephen Guyer for American City Business Journals Inc. All rights reserved.