Companies are not free from the risk of default.
Rating agencies estimate the likelihood of default for most corporate bonds and issue a rating
A rating is given to a security to indicate the likelihood of the borrower defaulting on the interest and principal payments.
Ratings are also given to loans, CDS, commercial paper.
Ratings are mandatory in the USA but not in the UK.
Some large UK companies do not have ratings, but this does not indicate that they are poor credits. If a bond is so popular it almost sells itself, why should the company pay for a rating.
why because if they get downgraded the risk goes up, so yield must go up which means bond price goes down
The ratings agencies have access to unpublished data which means that an official rating will often carry more weight.
These rating agencies accurately predict the long-term probability of default.
Companies that achieve investment grade status have a substantially lower cost of debt (and cost of capital).
The view of risk for a 3 month loan may be quite different from that for a 5 year loan.
Both organisations use a similar system for shoter-term commercial paper.
S & P - A1, A2, A3, B, C, D
S&P is usually used first and then moody's.
Look at the Gearing (ie how debt much debt does the company have)
Profit and Cash Flow (i.e. ability to pay debt)
Experince of management
Company prospects - cash generating potential
A credit rating agency could add a borrower to a "watchlist" if the future outlook for a rating is uncertain or under review.
Credit Rating agencies all use proprietary credit models to analyse credit risk (not market risk)
Credit losses on high rated borrowing should be less than those for lower rated borrowings
Credit rating agencies all use proprietary credit models to analyse credit risk (not market risk)
Standard & Poors
largely focus on probability of default
|S & P||Moody||Fitch|
|Investment Grade (High Grade)||AAA||Aaa||AAA||The highest rating. There capacity to meet their financial commitments is extremely strong. Typically government or supernational bonds|
|AA||Aa2||AA||High grade good quality, very safe|
|A||A2||A||Upper medium grade, safe The obligation is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions|
|BBB||Baa2||BBB||Medium grade, reasonable quality coporate bonds. Exhibts adequate protection|
|High Yield - Speculative||BB+||Ba1||BB+|
|BB||Ba2||BB||It faces major ongoing concerns which could lead to a wekended capcity to meet its financial commitments|
|B-||B3||B-||Adverse business, financial or econmoic conditions will likely impair their capacity to meet there financial commitments|
|Junk Bonds||CCC+||Caa1||CCC+||Currently vulnerable to non payment|
|CC+||Ca1||CC+||Highly vulnerable to non payment|
|D||D||In default or expected to default|
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