What Credit Ratings Are & Are NotCredit Ratings Are Expressions Of Opinion About Credit RiskCredit ratings are opinions about credit risk. Standard & Poor’s ratings express the agency’s opinion about the ability and willingness of an issuer, such as a corporation or state or city government, to meet its financial obligations in full and on time. Credit ratings can also speak to the credit quality of an individual debt issue, such as a corporate or municipal bond, and the relative likelihood that the issue may default. Ratings are provided by credit rating agencies which specialize in evaluating credit risk. In addition to international credit rating agencies, such as Standard & Poor’s, there are regional and Each agency applies its own methodology in measuring creditworthiness and uses a specific rating scale to publish its ratings opinions. Typically, ratings are expressed as letter grades that range, for example, from ‘AAA’ to ‘D’ to communicate the agency’s opinion of relative level of credit risk. |
A Matter of OpinionStandard & Poor’s ratings opinions are based on analysis by experienced professionals who evaluate and interpret information received from issuers and other available sources to form a considered opinion.
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What Credit Ratings Are & Are NotCredit Ratings Are Forward LookingAs part of its ratings analysis, Standard & Poor’s evaluates available current and historical information and assesses the potential impact of foreseeable future events. For example, in rating a corporation as an issuer of debt, the agency may factor in anticipated ups and downs in the business cycle that may affect the corporation’s creditworthiness. While the forward looking opinions of rating agencies can be of use to investors and market participants who are making long- or short-term investment and business decisions, credit ratings are not a guarantee that an investment will pay out or that it will not default. |
A Matter of OpinionStandard & Poor’s ratings opinions are based on analysis by experienced professionals who evaluate and interpret information received from issuers and other available sources to form a considered opinion.
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What Credit Ratings Are & Are NotCredit Ratings Do Not Indicate
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A Matter of OpinionStandard & Poor’s ratings opinions are based on analysis by experienced professionals who evaluate and interpret information received from issuers and other available sources to form a considered opinion.
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What Credit Ratings Are & Are NotCredit Ratings Are Not Absolute Measures Of Default ProbabilitySince there are future events and developments that cannot be foreseen, the assignment of credit ratings is not an exact science. For this reason, Standard & Poor’s ratings opinions are not intended as guarantees of credit quality or as exact measures of the probability that a particular issuer or particular debt issue will default. Instead, ratings express relative opinions about the creditworthiness of an issuer or credit quality of an individual debt issue, from strongest to weakest, within a universe of credit risk. For example, a corporate bond that is rated ‘AA’ is viewed by the rating agency as having a higher credit quality than a corporate bond with a ‘BBB’ rating. But the ‘AA’ rating isn’t a guarantee that it will not default, only that, in the agency’s opinion, it is less likely to default than the ‘BBB’ bond. |
A Matter of OpinionStandard & Poor’s ratings opinions are based on analysis by experienced professionals who evaluate and interpret information received from issuers and other available sources to form a considered opinion.
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Credit Rating Agencies: What They Do & How They DifferRating Agencies Evaluate Credit RiskSome credit rating agencies, including major global agencies like Standard & Poor’s, are publishing and information companies that specialize in analyzing the credit risk of issuers and individual debt issues. They formulate and disseminate ratings opinions that are used by investors and other market participants who may consider credit risk in making their investment and business decisions. In part because rating agencies are not directly involved in capital market transactions, they have come to be viewed by both investors and issuers as impartial, independent providers of opinions on credit risk. |
The Origin Of
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For Info on Other More information about the SEC’s designation of "NRSROs," related rules and other credit rating agencies is available at the U.S. Securities and Exchange Commission Web site. |
Credit Rating Agencies: What They Do & How They DifferRating MethodologiesIn forming their opinions of credit risk, rating agencies typically Analyst driven ratings. In rating a corporation or municipality, agencies using the analyst driven approach generally assign an analyst, often in conjunction with a team of specialists, to take the lead in evaluating the entity’s creditworthiness. Typically, analysts obtain information from published reports, as well as from interviews and discussions with the issuer’s management. They use that information to assess the entity’s financial condition, operating performance, policies, and risk management strategies. Model driven ratings. Other credit rating agencies focus almost exclusively on quantitative data, which they incorporate into a mathematical model. For example, an agency using this approach to assess the creditworthiness of a bank or other financial institution might evaluate that entity’s asset quality, funding, and profitability based primarily on data from the institution’s public financial statements and regulatory filings. |
S&P's Analyst Driven Rating Process |
Credit Rating Agencies: What They Do & How They DifferHow Agencies Are Paid For
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Who Uses Credit Ratings & WhyRatings & The Capital MarketsCredit ratings may play a useful role in enabling corporations and governments to raise money in the capital markets. Instead of taking a loan from a bank, these entities sometimes borrow money directly from investors by issuing bonds or notes. Investors purchase these debt securities, such as municipal bonds, expecting to receive interest plus the return of their principal, either when the bond matures or as periodic payments. Credit ratings may facilitate the process of issuing and purchasing bonds and other debt issues by providing an efficient, widely recognized, and long-standing measure of relative credit risk. Investors and other market participants may use the ratings as a screening device to match the relative credit risk of an issuer or individual debt issue with their own risk tolerance or credit risk guidelines in making investment and business decisions. For example, in considering the purchase of a municipal bond, an investor may check to see whether the bond’s credit rating is in keeping with the level of credit risk he or she is willing to assume. At the same time, credit ratings may be used by corporations to help them raise money for expansion and/or research and development as well as help states, cities, and other municipalities to fund public projects. |
Ratings And The
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Who Uses Credit Ratings & WhyInvestorsInvestors most often use credit ratings to help assess credit risk and to compare different issuers and debt issues when making investment decisions and managing their portfolios. Individual investors, for example, may use credit ratings in evaluating the purchase of a municipal or corporate bond from a risk tolerance perspective. Institutional investors, including mutual funds, pension funds, banks, and insurance companies often use credit ratings to supplement their own credit analysis of specific debt issues. In addition, institutional investors may use credit ratings to establish thresholds for credit risk and investment guidelines. |
Ratings And The
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Who Uses Credit Ratings & WhyIntermediariesInvestment bankers help to facilitate the flow of capital from investors to issuers. They may use credit ratings to benchmark the relative credit risk of different debt issues, as well as to set the initial pricing for individual debt issues they structure and to help determine the interest rate these issues will pay. Investment bankers and entities that structure special types of debt issues may look to a rating agency’s criteria when making their own decisions about how to configure different debt issues, or different tiers of debt. Investment bankers may also serve as arrangers of special debt issues. In this capacity, they establish special entities that package assets, such as retail mortgages and student loans, into securities, or structured finance instruments, which they then market to investors. |
Ratings And The
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Who Uses Credit Ratings & WhyIssuersIssuers, including corporations, financial institutions, national governments, states, cities and municipalities, use credit ratings to provide independent views of their creditworthiness and the credit quality of their debt issues. Issuers may also use credit ratings to help communicate the relative credit quality of debt issues, thereby expanding the universe of investors. In addition, credit ratings may help them anticipate the interest rate to be offered on their new debt issues. As a general rule, the more creditworthy an issuer or an issue is, the lower the interest rate the issuer would typically have to pay to attract investors. The reverse is also true: an issuer with lower creditworthiness will typically pay a higher interest rate to offset the greater credit risk assumed by investors. |
Ratings And The
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Who Uses Credit Ratings & Why
Businesses & Financial Institutions
Businesses and financial institutions, especially those involved in credit-sensitive transactions, may use credit ratings to assess counterparty risk, which is the potential risk that a party to a credit agreement may not fulfill its obligations.
For example, in deciding whether to lend money to a particular organization or in selecting a company that will guarantee the repayment of a debt issue in the event of default, a business may wish to consider the counterparty risk.
A credit rating agency’s opinion of counterparty risk therefore can help businesses to analyze their credit exposure to financial firms that have agreed to assume certain financial obligations and to evaluate the viability of potential partnerships and other business relationships.
The ABC's of Rating ScalesA Simple, Efficient Way to
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Opinions Reflected
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Ratings Definitions View the complete list of Standard & Poor’s Ratings Definitions. |
The ABC’s of Rating ScalesInvestment- & Speculative-Grade DebtThe term “investment grade” historically referred to bonds and other debt securities that bank regulators and market participants viewed as suitable investments for financial institutions. Now the term is broadly used to describe issuers and issues with relatively high levels of creditworthiness and credit quality. In contrast, the term “non-investment grade,” or “speculative grade,” generally refers to debt securities where the issuer currently has the ability to repay but faces significant uncertainties, such as adverse business or financial circumstances that could affect credit risk. In Standard & Poor’s long-term rating scale, issuers and debt issues that receive a rating of ‘BBB–’ or above are generally considered by regulators and market participants to be “investment grade,” while those that receive a rating lower than ‘BBB–’ are generally considered to be “speculative grade.” |
Opinions Reflected
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The ABC’s of Rating ScalesRecovery RatingsCredit rating agencies may also assess recovery, which is the likelihood that investors will recoup the unpaid portion of their principal in the event of default. Some agencies incorporate recovery as a rating factor in evaluating the credit quality of an issue, particularly in the case of non-investment-grade debt. Other agencies, such as Standard & Poor’s, issue recovery ratings in addition to rating specific debt issues. Standard & Poor’s may also consider recovery ratings in adjusting the credit rating of |
Ratings DefinitionsView the complete list of Standard & Poor’s Ratings Definitions. |
Process For Rating Issuers & IssuesRating Issuers & IssuesCredit rating agencies assign ratings to issuers, such as corporations and governments, as well as to specific debt issues, such as bonds, notes, and other debt securities. |
S&P's Analyst Driven Rating Process |
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Process For Rating Issuers & IssuesRating An IssuerTo assess the creditworthiness of an issuer, Standard & Poor’s evaluates the issuer’s ability and willingness to repay its obligations in accordance with the terms of those obligations. To form its ratings opinions, Standard & Poor’s reviews a broad range of financial and business attributes that may influence the issuer’s prompt repayment. The specific risk factors that are analyzed depend in part on the type of issuer. For example, the credit analysis of a corporate issuer typically considers many financial and non-financial factors, including key performance indicators, economic, regulatory, and geopolitical influences, management and corporate governance attributes, and competitive position. In rating a sovereign, or national government, the analysis may concentrate on political risk, monetary stability, and overall debt burden. For high-grade credit ratings, Standard & Poor’s considers the anticipated ups and downs of the business cycle, including industry-specific and broad economic factors. The length and effects of business cycles can vary greatly, however, making their impact on credit quality difficult to predict with precision. In the case of higher risk, more volatile speculative-grade ratings, Standard & Poor’s factors in greater vulnerability to down business cycles. |
S&P's Risk Factors
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Process For Rating Issuers & Issues
Rating An Issue
In rating an individual debt issue, such as a corporate or municipal bond, Standard & Poor’s typically uses, among other things, information from the issuer and other sources to evaluate the credit quality of the issue and the likelihood of default. In the case of bonds issued by corporations or municipalities, rating agencies typically begin with an evaluation of the creditworthiness of the issuer before assessing the credit quality of a specific debt issue.
In analyzing debt issues, for example, Standard & Poor’s analysts evaluate, among other things:
- The terms and conditions of the debt security and, if relevant, its legal structure.
- The relative seniority of the issue with regard to the issuer’s other debt issues and priority of repayment in the event of default.
- The existence of external support or credit enhancements, such as letters of credit, guarantees, insurance, and collateral. These protections can provide a cushion that limits the potential credit risks associated with a particular issue.
Process For Rating Issuers & IssuesRating Structured Finance InstrumentsA structured finance instrument is a particular type of debt issue created through a process known as securitization. In essence, securitization involves pooling individual financial assets, such as mortgage or auto loans, and creating, or structuring, separate debt securities that are sold to investors to fund the purchase of these assets.
Stratifying a pool of undifferentiated risk into multiple classes of bonds with varying levels of seniority is called tranching. Investors who purchase the senior tranche, which generally has the highest quality debt from a credit perspective and the lowest interest rate, are the first to be repaid from the cash flow of the underlying assets. Holders of the next-lower tranche, which pays a somewhat higher rate, are paid second, and so forth. Investors who purchase the lowest tranche generally have the potential to earn the highest interest rate, but they also tend to assume the highest risk. In forming its opinion of a structured finance instrument, Standard & Poor’s evaluates, among other things, the potential risks posed by the instrument’s legal structure and the credit quality of the assets the SPE holds. Standard & Poor’s also considers the anticipated cash flow of these underlying assets and any credit enhancements that provide protection against default. |
Creation Of Structured Finance Instruments |
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Monitoring Credit QualitySurveillance: Tracking Credit QualityAgencies typically track developments that might affect the credit risk of an issuer or individual debt issue for which an agency has provided a ratings opinion. In the case of Standard & Poor’s, the goal of this surveillance is to keep the rating current by identifying issues that may result in either an upgrade or a downgrade. In conducting its surveillance, Standard & Poor’s may consider many factors, including, for example, changes in the business climate or credit markets, new technology or competition that may hurt an issuer’s earnings or projected revenues, issuer performance, and regulatory changes. The frequency and extent of surveillance typically depends on specific risk considerations for an individual issuer or issue, or an entire group of rated entities or debt issues. In its surveillance
As a result of its surveillance analysis, an agency may adjust the credit rating of an issuer or issue to signify its view of a higher or lower level of relative credit risk.
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Monitoring Credit Quality
Why Credit Ratings Change
The reasons for ratings adjustments vary, and may be broadly related to overall shifts in the economy or business environment or more narrowly focused on circumstances affecting a specific industry, entity, or individual debt issue.
In some cases, changes in the business climate can affect the credit risk of a wide array of issuers and securities. For instance, new competition or technology, beyond what might have been expected and factored into the ratings, may hurt a company’s expected earnings performance, which could lead to one or more rating downgrades over time. Growing or shrinking debt burdens, hefty capital spending requirements, and regulatory changes may also trigger ratings changes.
While some risk factors tend to affect all issuers—an example would be growing inflation that affects interest rate levels and the cost of capital—other risk factors may pertain only to a narrow group of issuers and debt issues. For instance, the creditworthiness of a state or municipality may be impacted by population shifts or lower incomes of taxpayers, which reduce tax receipts and ability to
repay debt.
Monitoring Credit Quality
When Ratings Change
Credit rating adjustments may play a role in how the market perceives a particular issuer or individual debt issue. Sometimes, for example, a downgrade by a rating agency may change the market’s perception of the credit risk of a debt security which, combined with other factors, may lead to a change in the price of that security.
Market prices continually fluctuate as investors reach their own conclusions about the security’s shifting credit quality and investment merit. While ratings changes may affect investor perception, credit ratings constitute just one of many factors that the marketplace should consider when evaluating debt securities.
Ratings Behavior/PerformanceTransition & Default StudiesTo measure the performance of its credit ratings, Standard & Poor’s conducts studies to track default rates and transitions, which is how much a rating has changed, up or down, over a certain period of time. Agencies use these studies to refine and evolve their analytic methods in forming their ratings opinions. Transition rates can also be helpful to investors and credit professionals because they show the relative stability and volatility of credit ratings. For example, investors who are obligated to purchase only highly rated securities and are looking for some indication of stability may review the history of rating transitions and defaults as part of their investment research. | Default, Transition & Recovery StudiesStandard & Poor’s Default, Transition & Recovery Studies are available on its public website. |
Further Readings
These are unprecedented times in the capital markets and confidence has been shaken by recent events. At Standard & Poor's, our top priority is helping to restore investor confidence. We have undertaken a number of new initiatives in our ratings and are continuing to think of ways we can enhance our ratings process. We are also listening to investors, issuers, commentators, policymakers, regulators, and others for new ideas and approaches. We believe all of these entities need to play an active role in strengthening our markets.
MoreAn Examination Of How Investor Needs Are Served By Various Ratings Business Models
Credit rating organizations have served investors and the markets well for over 90 years, but, regrettably, ratings on U.S. housing-related structured securities in recent years have not, generally speaking, performed as well as intended. Subsequently, ratings firms have made many changes and are working with regulators and policymakers around the world to help restore confidence in the credit markets and stimulate recovery.
In a world of increasing complexity, the perfect capital measure--simple and transparent enough to be understood, sensitive to the specific risks of each bank, consistent and comparable across institutions--does not appear achievable in our view. Indeed, we believe that overreliance on one single metric carries many unintended consequences. Culminating a three-year-long research project, we're introducing our risk-adjusted capital framework for measuring capital adequacy at financial institutions worldwide.
U.S. Corporate Default Rate Forecasted To Reach 14.3% By March 2010
The U.S. corporate speculative-grade default rate has risen sharply this year, and we expect that it will reach an all-time high of 14.3% by March 2010. Historically, defaults have continued to escalate even after signs of economic recovery. This cycle will be no different. We expect the economy to bottom out in the third quarter of 2009, but default occurrences likely will be abundant past that time horizon.
Will The U.S. Dollar Be Clipped?
People's Bank of China Governor Zhou Xiaochuan recently sparked a new round of debate regarding the international monetary regime with his call for a new international reserve currency. While the U.S. dollar was not specifically mentioned, it is clear that the proposed new international currency is meant to replace the U.S. dollar's role. There appears to be some international support for the idea. So will we see the U.S. dollar losing its international pre-eminence anytime soon?
2008 Annual Global Corporate Default Study And Rating Transitions
Following many years of favorable credit conditions, ratings trends deteriorated dramatically in 2008. Not coincidentally, default occurrences picked up sharply in 2008 in each progressive quarter, which is a stark contrast with the ultra-low default rates of recent years. The 2008 default tally was 125, with a quarterly distribution of 18, 20, 27, and 60 in the first through fourth quarters, respectively. Expressed as a percentage of the total issuer count, the global default rate rose to 1.69% in 2008 from 0.36% a year earlier.
We have consistently supported a single set of global financial reporting standards. We believe that a single body of high-quality standards, established by a well governed and adequately funded global accounting standard setter, applied uniformly by companies, and enforced consistently by auditors and regulators, will better enable our analyses of global peer companies. It will also enhance the accounting standard-setting process and underpin the efficient operation of the global capital markets.
U.S. Economic Forecast: The End Of The Beginning
To paraphrase Winston Churchill, the recession isn't at its end, or even the beginning of its end, but it may be at the end of the beginning, with the biggest drops behind us. We expect the first quarter to be another bad quarter, with real GDP dropping 5.8%, similar to the fourth quarter. But declines will moderate in the second quarter, and we expect the third quarter to be nearly flat. There are some encouraging signs amid the continuing gloom.
U.S. Housing's Long And Winding Road To Recovery
The U.S. housing market continues to deteriorate, with house prices sliding as foreclosures hit record levels. Although we believe that house sales and starts may be finding a bottom, the excess inventory of unsold homes makes it likely that prices will continue to decline for another year. Restoring equilibrium requires the U.S. build far fewer homes and the cost of homes to come down to levels consistent with incomes.
Most European Housing Markets Brace For Further Price Slides
How low residential housing prices may tumble and for how long before recovery kicks in are major concerns in Europe. The price declines and falling transaction volumes that we've witnessed in most West European residential real estate markets since 2007 are poised to continue, in our view. But when we look at individual countries, the magnitude and timeframe of anticipated drops vary.
