Rating Systems In all systems the term high grade means low default risk, or conversely,

Rating Systems In all systems the term high grade means low default risk, or conversely,

high probability of future payments. The highest-grade bonds are desig- nated by Moody’s by the symbol Aaa, and by the other two rating agen- cies by the symbol AAA. The next highest grade is denoted by the symbol Aa (Moody’s) or AA (the other two rating agencies); for the third grade all rating agencies use A. The next three grades are Baa or BBB, Ba or BB, and B, respectively. There are also C grades.

Intermediate and Long-Term Debt

EXHIBIT 15.4 Summary of Corporate Bond Rating Systems and Symbols

Fitch Moody’s S&P

Summary Description

Investment Grade—High Creditworthiness

AAA Aaa AAA Gilt edge, prime, maximum safety AA+

Aa1 AA+ AA Aa2

AA High-grade, high-credit quality AA −

Aa3 AA − A+

A1 A+

A A2 A Upper-medium grade

A − A3 A − BBB+

Baa1 BBB+ BBB

Baa2 BBB

Lower-medium grade

BBB − Baa3 BBB −

Speculative—Lower Creditworthiness

BB+ Ba1 BB+ BB Ba2

BB Low grade, speculative

BB − Ba3 BB − B+

B1

B B2 B Highly speculative

B − B3

Predominantly Speculative, Substantial Risk, or in Default

CCC+ CCC+ CCC

Caa CCC Substantial risk, in poor standing CC Ca CC May be in default, very speculative

C C C Extremely speculative CI Income bonds—no interest being paid

DDD

DD Default

FINANCING DECISIONS

Bonds rated triple A (AAA or Aaa) are said to be prime; double A (AA or Aa) are of high quality; single A issues are called upper-medium grade; and triple B are medium grade. Lower-rated bonds (i.e., bonds rated below triple B) are said to have speculative elements or be dis- tinctly speculative.

All rating agencies use rating modifiers to provide a narrower credit quality breakdown within each rating category. S&P and Fitch use a rat- ing modifier of plus and minus. Moody’s uses 1, 2, and 3 as its rating modifiers.

Bond issues that are assigned a rating in the top four categories are referred to as investment-grade bonds. Issues that carry a rating below the top four categories are referred to as noninvestment-grade bonds or

speculative bonds, or more popularly as high-yield bonds or junk

bonds. Thus, the corporate bond market can be divided into two sec- tors: the investment-grade and noninvestment-grade markets.

Ratings of bonds change over time. Issuers are upgraded when their likelihood of default (as assessed by the rating agency) decreases, and downgraded when their likelihood of default (as assessed by the rating agency) increases.

It is important to remember that debt ratings reflect credit quality only—no evaluation is done of other risks (e.g., interest rate risk) associ- ated with the debt. The rating process involves the analysis of a multi- tude of quantitative and qualitative factors over the past, present, and future. The ratings apply to the particular issue, not the issuer. A rating is only an opinion or judgment of an issuer’s ability to meet all of its obligations when due, whether during prosperity or during times of stress. The purpose of ratings is to rank issues in terms of the probabil- ity of default, taking into account the special features of the issue, the relationship to other obligations of the issuer, and current and prospec- tive financial condition and operating performance.