What is a corporate credit rating?
A corporate credit rating is an independent agency opinion regarding the likelihood that a corporation will fully meet its financial obligations when due. The corporate credit rating of a company indicates its relative ability to pay its creditors. It is important to note that corporate credit ratings are an opinion, not a fact.
- Corporate credit ratings are the evaluation of a company’s ability to pay its debts according to an independent credit rating agency.
- The three largest credit rating agencies are: Standard and Poor’s (S&P), Moody’s and Fitch.
- Trends in corporate credit ratings over time can allow an investor to compare the credit worthiness of competing corporations.
- Credit rating agencies are notoriously criticized for their potential bias and role in the 2008 financial crisis.
Understanding corporate credit ratings
Standard & Poor’s (S&P), Moody’s and Fitch are the top three providers of corporate credit ratings. Each agency has its own rating system that does not necessarily correspond to the rating scale of the other agencies, but they are all similar. For example, Standard & Poor’s uses “AAA” for the highest credit quality with the lowest credit risk, “AA” for the next best, followed by “A”, then “BBB” for satisfactory credit.
These ratings are considered investment grade, which means that the security or corporation being rated has a level of quality that many institutions require. Anything below “BBB” is considered speculative or worse, up to a rating of “D”, which indicates default or “junk”.
The following chart provides an overview of the different ratings issued by Moody’s and Standard & Poor’s:
|Moody’s||Standard and poor||Fitch||Qualification||Risk|
|Dad, BOOM||BB, B||BB, B||Scrap||High risk|
|Caa / Ca||CCC / CC / C||CCC / CC / C||Scrap||Higher risk|
Corporate credit ratings are not a guarantee that a company will repay its obligations. However, the long-term history of these ratings reflects variations in credit quality among rated companies, especially when compared within the same industry. In 2020, the default rate for speculative grade bonds was 5.5% and investment grade default rates were 0%.
Since ratings are opinions, ratings for the same company may differ between rating agencies. Investment research firm Morningstar also provides corporate credit ratings ranging from AAA for extremely low risk of default to D for default.
Criticisms of corporate credit ratings
A key criticism is that the issuers themselves pay the credit rating agencies to rate their securities. This became particularly important when the growing housing market peaked in 2006-2007, and agencies rated a significant amount of subprime debt. The potential to earn high fees created competition among the top three agencies to issue the highest possible ratings.
During the 2008 financial crisis, companies that had previously received glowing ratings from various credit rating agencies were downgraded to junk levels, putting the reliability of the ratings themselves into question.
The persistent criticism that has plagued the rating agencies is that they are not truly impartial because the issuers themselves pay the rating agencies. According to critics, to secure the work to perform a rating, a rating agency could give the issuer a rating it wanted or could sweep under the rug anything that negatively impacts a positive credit rating. Credit bureaus came under intense fire, for good reason, when the credit crunch autopsy took place.